Sustainable Economics | November 24, 2015 · Sustainable Economics November 24, 2015 Mind The Inequality Gap This note focuses on growing inequality in DM countries and how it may

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Sustainable EconomicsSustainable EconomicsNovember 24, 2015

Mind The Inequality Gap

This note focuses on growing inequality in DM countries and how itmay impact investment. Inequality is inherent in market processes.However, when persistent, it can harm growth over the long run.

Inequality matters for market participants. It affects consumption,investment, and, at some levels, catalyzes growth, by acting as an incentive. Itsnature is complex: it stems from a variety of factors, including random events,economies of scale, capital deepening, and technological progress.

However, when protracted, inequality can disrupt business models, fuelpolitical discontent and trigger policy missteps. This could damage thegrowth potential. This risk is high in DM, where inequality within countries isincreasing, in contrast to inequality between countries globally, which isdiminishing. In the note, we focus particularly on Europe and the U.S.

We address five questions: Why does inequality matter for investors? Isinequality going up or down? How does it affect growth? Will it bring themiddle class to an end? Which signals should investors watch out for?

Complementing traditional inequality measures, our MS InequalityIndicator (MSII) maps country performance. Southern European countriesand the US score poorly on the MSII. Among the well scoring Nordic countries,Sweden has experienced the largest increase in inequality since the mid 1980s,although the overall score remains comparatively low.

MS stock analysts highlight how companies are adapting to marketpolarization and how the incentives coinciding with inequality canstimulate innovation and inclusiveness to a certain degree. In particular,technology can help enhance the accessibility, availability and affordability ofgoods and services, particularly in telecommunication and the automotivesector.

Our analysts highlight the pharma sector as most exposed to risingpolicy risks, although this is not an exhaustive list. They also point toincreasing inequality as an opportunity for companies capable ofembracing complexity. This implies best supply chains, best process andtechnology or even marketing strategies that are able to adapt to changingconditions quickly. Companies our analysts view as well positioned for thegrowing inequality gap include Nestlé (NESN), Constellation Brands (STZ),Estée Lauder (EL), White Wave (WWAV) and Mondelez (MDLZ) in the staplessector, and Ryanair (RYA), Delta Air Lines (DAL) and Spirit Airlines (SAVE) intransport.

Exhibit 1:Exhibit 1: Inequality Up in the OECD since the mid-1980s.

Sou rce: O ECD, Morgan Stan ley Research

Exhibit 2:Exhibit 2: Southern European Countries and the US Top MSInequality Indicator Ranking

Note: 1 = most u n equ al. See Exh ib it 3 fo r more in fo rmation abou t th e ran k in g

meth odo logy. Sou rce: O ECD, Morgan Stan ley Research

Morgan Stanley does and seeks to do business withcompanies covered in Morgan Stanley Research. As a result,investors should be aware that the firm may have a conflictof interest that could affect the objectivity of MorganStanley Research. Investors should consider MorganStanley Research as only a single factor in making theirinvestment decision.For analyst certification and other important disclosures,For analyst certification and other important disclosures,refer to the Disclosure Section, located at the end of thisrefer to the Disclosure Section, located at the end of thisreport.report.

| November 24, 2015Sustainable Economics

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Economics

Carmen Nu zzo + 44 20 7677-0209 Carmen .Nu zzo@ morgan stan ley.com

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Sustainable and Responsible

Jessica Alsfo rd + 44 20 7425-8985 Jessica .Alsfo rd@ morgan stan ley.com

Eva Zlo tn icka + 1 212 761-4075 Eva .Zlo tn icka@ morgan stan ley.com

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Consumer Staples

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Vin cen t Meu n ier + 44 20 7425-8273 Vin cen t.Meu n ier@ morgan stan ley.com

David R isin ger + 1 212 761-6494 David .R isin ger@ morgan stan ley.com

Matth ew Harrison + 1 212 761-8055 Matth ew .Harrison @ morgan stan ley.com

Ricky G o ldw asser + 1 212 761-4097 R icky.G o ldw asser@ morgan stan ley.com

David R Lew is + 1 415 576-2324 David .R .Lew is@ morgan stan ley.com

An drew Sch en ker + 1 212 761-6857 An drew .Sch en ker@ morgan stan ley.com

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Elen a Marian i + 44 20 7425-0527 Elen a .Marian i@ morgan stan ley.com

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Retail

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Kimberly C G reen berger + 1 212 761-6284 Kimberly.G reen berger@ morgan stan ley.com

Edou ard Au b in + 44 20 7425-3160 Edou ard .Au b in @ morgan stan ley.com

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Transport

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Vau gh an Lew is + 44 20 7425-3489 Vau gh an .Lew is@ morgan stan ley.com

Th omas Allen + 1 212 761-3356 Th omas.Allen @ morgan stan ley.com


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Table of ContentsTable of Contents

The Inequality Debate 4

Mind the Inequality Gap 5

Inequality of What? 8

Has Inequality Gone Up or Down? 12

The End of the Middle Class? 17

How Can Inequality Affect Economic Growth? 21

Looking Ahead: What to Monitor 28

Autos: Ripe for disruption, improving equality 32

Consumer Staples: Bifurcation into low-end and high-end consumers 36

Healthcare: A Tale of Multi-Regionalism - The Rise of the Healthcare Consumerin the US and Push for Innovation in the EU

51

Luxury: Providing entry for the 'aspirational' consumer 57

Retail: Expanding value segment with expanding inequality 60

Technology: Great equalizer until now, but polarization a possibility 62

Transport: Mobility and segmentation provide flexibility to adapt 64

Leisure: Bifurcation with a bent towards the high end 68


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The Inequality DebateThe Inequality Debate

DEBATE CONSENSUS VIEW OUR VIEW

Inequality isrising on variousmetrics. Shouldinvestors care?

No, investors shouldcare only aboutinvestment andgrowth opportunities.

Growth matters but so does its distribution. Inequality is inherent in economicprocesses but its persistence - when it prevents social mobility and perpetuatesdiscrepancies - is pernicious. It may pose entry barriers to health and education, assetsand access to credit, employment opportunities, political representation and basicinfrastructure. Thus, rather than working as a catalyst for social mobility (acting as areward for differences in efforts or responsibility), widening and protracted inequalitymay trigger social immobility by perpetuating it.

Inequality arises due to a variety of factors. For example, it can be triggered byinnovation, it can be the result of economies of scale, capital deepening and newtechnologies. In turn, these changes boost demand for highly skilled workers, and givean advantage to those with access to good education. It can also be triggered by luckor people’s choices, including time preference in their consumption and allocation ofsavings.

Measuring inequality is difficult though. For a start it can be apply to differentconcepts, e.g. gender, pay. Moreover, its notion varies over time and is often linked withsocial factors (such as again gender or race, class and culture). In this note we focus oninequality of income, wealth and consumption which are particularly relevant from aneconomic point of view.

Is inequalitydecreasingglobally?

Yes, based on GDPper capita,international incomeinequality hasdropped in recentyears.

Inequality between countries globally has diminished but it has risen withinseveral countries, especially in the OECD. The rise of GDP per capita in manyemerging countries, especially China and India, in recent years has narrowed the gapversus developing countries, including that of life expectancy. However, income andwealth inequalities within countries, including China, have increased in many countries,including in the US and many European countries.

Inequality can become an inhibitor of growth through various channels: 1)business models can be disrupted, as they become bifurcated. This splitting canbecome riskier and unsustainable over time. 2) government policies can be affectedwith potential backlashes for economic growth via increased market regulation,protectionist and anti-immigration measures; 3) voters choices can be influenced,potentially degenerating into social unrest . Increased voters’ disengagement anddisenchantment with politics are also a risk. Furthermore, there could be tensions withgrassroots, if the views of the most affluent appear to count more, when it comes tosetting policy.

Is this not apolicy/politicalissue?

This is a politicalissue and is at theheart of those whofavor a moreinterventionist policyapproach

This is an economic issue because inequality may distort the allocation ofresources, even abstracting from the debate of whether countries should favor a lessgovernment interventionist or a more redistributive approach. There might be athreshold beyond which inequality can harm the economy, although determining the'tipping point' is difficult. Put it differently, ‘igniting’ growth might be less challengingthan sustaining growth if the model of growth is not viable over the long run.

Therefore, inequality developments warrant investors' attention. For example, in thecountries which score poorly according to the MSII indicator, social discontent seems tobe on the rise, judging from the increase in the support for the non-mainstream politicalparties compared to a year ago.


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Mind the Inequality GapMind the Inequality Gap

Summary and Conclusions

Does inequality matter for long-term economic prosperity? That growth matters is well understoodbut its distribution is often overlooked. Economic growth increases production, boosts living standards andcreates jobs. However, the distribution of the income that economic growth generates matters as well. If thedistribution is too uneven with a persistent and widening gap between the top and the bottom of the scale, itprevents broad participation in the welfare gains of growth, and, over time, risks corroding the economic andsocial fabric of a country. As a result, inequality could potentially disrupt business models, social consensus andlead to policy mistakes.

While inequality is not a subject typically discussed among financial market participants, it mattersfor their investment decisions. Inequality alters the distribution of consumption and savings, as well as theallocation of resources more generally. As a result, it would benefit investors to become more aware of thedrivers of inequality in the countries or sectors where they invest. So far, globalization, a widening wage gap,increasing ‘underemployment’, the divide between generations and amongst the same generation appear tohave contributed to a widening trend of inequality within many countries. The Great Recession and the financialcrisis have exacerbated this (see Exhibit 1Exhibit 1 on the cover).

The public inequality debate focuses largely on the eye-catching rich '1%' and redistributionalpolicies but overlooks that inequality is the side effect of dynamic processes such as innovation andsocial mobility. In fact, evidence of the impact of inequality on economic growth is not clear-cut. Moreover, byfocussing largely on the effect that recent technological advancements have had on the labor market - by eithersubstituting jobs with increased automation or widening the wage gap between skilled and unskilled labor - thedebate overlooks the progress that technology has brought via better living standards, broader availability,accessibility and affordability of goods and services.

Inequality can become dangerous when it is entrenched though. When it pre-determines individuals'positioning along the income and wealth distribution independently of their efforts, inequality hinders access toopportunities. Therefore, it undermines incentives to work hard and invest in further education and improveskills. It is then that it can take a heavy economic toll on future economic growth. Furthermore, inequality canundermine trust in policymakers and social institutions.

Here, we analyze inequality across DM in recent years, with a special focus on Europe and the U.S. Thedebate started relatively earlier in the US (see US Economics: Inequality and ConsumptionInequality and Consumption, September 22,2014) where it has already prompted some policy action such as the recent increases in state-level minimumwages, and has recently spread to Europe. In both cases, it has been reinvigorated by the Great Recession, whichlaid bare the burden of high private sector debt. This year's award of the Nobel Memorial Prize in EconomicSciences to Economist Angus Deaton, citing his lifetime contribution to understanding the relationship betweenconsumption and income, as well as his work on health, well-being and inequality, is emblematic of theprominence of the inequality focus in academia.

In the inequality debate, objective facts that drive the economy matter, as well as subjectiveperceptions. Indeed, personal perceptions on inequality may differ from actual levels of inequality. A wealth ofstudies indicates that Europeans perceive their countries to be far less equal than statistics measure, whileAmericans tend to believe their country is somewhat more equal than statistics show, possibly due to differentperceptions of opportunities for mobility. Perceptions are subjective and can vary with time, but they matter forinequality tolerance in a country.

The Morgan Stanley Inequality Indicator (MSII) points to a picture that is more nuanced than whatthe traditional Gini coefficient might suggest. By aggregating several indicators, especially labor marketones, it captures different aspects of inequality and the fact that it is multi-faceted. Some countries seem to


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https://ny.matrix.ms.com/eqr/article/webapp/bbef3514-1da3-11e4-88d8-349e888f8058?ch=rpext#0

perform persistently worse than others (see Exhibit 3Exhibit 3). For example, Southern European countries and theUS score poorly. When assessing changes since the mid 1980s, however, the surprise is in the Nordic countries,especially Sweden, which has experienced some of the largest increases in inequality in the last 30 years, albeitretaining a comparatively low score.

Looking ahead, it is difficult to predict how inequality will evolve, because of its multi-dimensionality: wehighlight three areas that can create opportunities but also potentially exacerbate existinginequalities:

The risk scenario for investors is that rising inequality creates a disenfranchised cohort whose members withinadequate education and low skills are alienated from participation in the economy, thus lowering potentialGDP growth. In these countries, we believe investors should be wary of signs of reform fatigue, socialunrest and political discontent that may destabilize the markets in which they invest or undermine businessmodels.

Key Equity Analysts' Conclusions

The results of our equity research teams' stock analysis of consumer-driven sectors through the inequality lenshighlights two dimensions:

Exhibit 3:Exhibit 3: Summary of Selected Inequality Indicators

HealthStatus

DigitalAccess

Change inGini

Coefficients%

RealWageGrowth

%

EarningsDispersion

GenderPay Gap

Mean toMedian Net

Wealth

MedianDebt toIncome

%

SecondaryEducation

Unemployment%

InvoluntaryPart Time

%

NEET%

Gap inHealth

Status %

InternetAccess

%

Portugal 1 34 -6.3 -0.5 4.1 16 2.0 134 14.3 3.2 17.3 25 65Italy 2 33 4.4 -0.1 2.3 11 1.6 50 8.8 6.6 26.1 14 62Greece 3 34 2.1 -1.7 3.0 7 1.4 47 26.3 3.2 28.5 17 63Spain 4 34 2.3 0.4 3.1 9 1.6 114 23.0 5.8 26.8 15 76United States 5 40 6.1 0.7 5.1 18 7.2 133 8.2 1.0 16.0 22 87Germany 6 29 0.6 0.6 3.4 17 3.6 37 6.9 2.8 9.7 25 86Australia 7 33 -3.0 0.9 3.5 18 1.6 96 5.2 5.2 13.0 17 85Austria 8 28 -2.8 0.5 3.3 18 3.6 36 6.0 2.2 9.6 27 81Ireland 9 30 -0.3 1.9 3.9 13 12.3 5.6 19.2 15 80Canada 10 32 -0.9 2.0 3.8 19 2.2 161 6.8 3.2 12.4 15 87Poland 11 30 -5.6 1.2 4.1 11 8.3 1.4 17.0 17 67United Kingdom 12 35 -2.8 -0.3 3.5 17 1.8 11 4.5 3.4 15.6 19 92Japan 13 34 2.0 0.0 3.0 27 4.8 3.8 7.2 11 91France 14 31 4.4 0.9 3.0 14 2.0 50 8.0 4.6 16.3 13 84Switzerland 15 28 -1.3 1.1 2.7 19 5.6 1.9 9.0 20 87Belgium 16 27 -5.0 0.2 2.5 6 1.7 80 6.5 1.5 14.9 30 85Netherlands 17 28 -5.8 0.7 2.9 20 5.0 194 5.9 3.6 8.9 20 93Finland 18 26 -2.8 0.9 2.6 19 1.9 64 7.6 2.2 12.3 26 92Sweden 19 27 5.7 1.6 2.3 15 5.9 4.8 9.4 21 93Norway 20 25 1.0 2.3 2.4 7 1.9 180 3.6 1.0 9.1 20 96

MSInequalityIndicator

(MSII)

Wage DispersionGini

Coefficients

Workplace InclusionBalance Sheet

Note: Th e earn in gs d ispersion is measu red by th e ratio o f 9th to 1st decile limits o f earn in gs.Th e gen der w age gap is th e d if feren ce betw een th e

med ian earn in gs o f men an d w omen relative to th e med ian earn in gs o f men . Th e in vo lu n tary part-time is as a sh are o f th e popu lation . NEET is th e

sh are o f you th as a percen tage o f th e 16-24 age coh ort w h ich is n eith er emp loymen t n o r in edu cation o r tra in in g . Th e gap in h ealth statu s is th e

d if feren ce betw een th e perceived statu s by h igh -low in come in d ividu als. B a lan ce sh eet data are fo r 2010-11 an d are n o t ava ilab le fo r Sw eden ,

Sw itzerlan d , Po lan d , Irelan d an d Japan . All data refer to 2013 o r latest ava ilab le. Th e average rea l w age g row th is over 2004-2014.


1) outsourcing,which is increasingly extending from the manufacturing sector - including viaoffshoring - to services via the rise of the shared economy;

2) migration, a positive in ageing DM countries on many fronts but which could boostinequality during the integration process of migrants into the recipient states;

3) technology, which has transformed the organization of production by polarizing the labormarket due to outsourcing and automation but has also relieved workers from menial tasksand improved living standards.

1) significant market polarization along the price and quality product spectrum and

2) the positive role that technology plays to enhance growth inclusiveness,


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Greater product differentiation, with more price and quality segmentation at the top and the bottomof the offering range, would probably continue should the inequality gap increase. In airlines, forinstance, our transport team notes that low cost carriers have been growing market share but premium brandsare also experiencing growth.

Overall, our analysts expect that middle-income customers would likely continue to exist but wouldbecome more selective. This means that middle-income consumers would be more opportunistic in terms ofpricing but also inclined to make the occasional higher-end purchases. Therefore, companies capable ofembracing complexity should outperform, i.e. the companies that will be able to adapt to changingconditions quickly, implying best supply chains, best process, technology and innovation, even via newmarketing strategies.

Mobile devices and the auto sector provide two good examples of how technology has helped toreduce consumption inequalities relative to income inequalities. Our analyst teams show thatconsumption in these sectors is becoming more inclusive, with companies able to offer broader product optionsand facilitating access to goods and services, although this does not reduce income inequality. Mobile devices,for example, have provided users with access to communication and the mobile internet and even encouragedfinancial inclusion in some countries. Our Technology team estimates that 2.5B people in the world ownsmartphones, compared to about 1.5B owning personal computers (PCs). Moreover, our Autos team argues thatinnovations like the technology behind autonomous cars, and connected car technology, could provide greatertransportation access to the masses, whilst making cars more approachable, affordable and safe.


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Inequality of What?Inequality of What?

Inequality is a broad and complex concept, with many different facets: it can span from access to education,health services to gender, age or race. Therefore it can be analysed from different angles. From an economicpoint of view, it is inequality of income and wealth (as well as its repercussion on consumption) that seems tomatter, and it is on this that we will focus in this report.

Inequality is inherent in economic processes. In a market economy there will always be winners and losers.For example, for many failed attempts to invent, there are a few successful innovations. These create atemporary advantage and reward the innovators with profits, which partially compensate them for taking risks.Eventually, the profit advantage of those inventors wanes though, as the original idea gets copied andcompetition increases. The problem arises when the 'winners' are always the same, opportunities are not opento all and 'path dependency' emerges – in other words when the position of individuals in the inequalitydistribution is 'pre-determined' and discourages them from putting in an extra effort to work harder or get abetter education.

Inequality arises due to a variety of factors in addition to innovation: for instance, it can be the result ofeconomies of scale, capital deepening and new technologies, which can improve productivity, but alsodetermine a different allocation of labor resources, for example by introducing a 'skill bias' in the demand forlabour that might force lower-skilled workers to exit the labour force. It can also be triggered by people’schoices, including different life-style and time preferences, both with different allocations to consumption andsavings. Finally, it could be the result of random events such as luck, as Bank of England Governor Mark Carney

also recently observed.

Low wage gains and private sector household debt have contributed to widening inequality withinDM. This has likely been exacerbated by QE. Exhibit 4Exhibit 4 shows that since the mid 1980s, householddisposable income bottom 10% has risen by ~ 15% whilst the top 10% by ~50%. Therefore, widening inequalityhas attracted increasing attention from policymakers, international institutions and media. Indeed, since theheight of the financial crisis in 2008, press communiqués of G20 leaders’ summits have regularly featuredwords such as ‘social inclusion’ or 'inclusive recovery’ among their pledges, referring to the need to broaden thedistribution of the ‘dividends’ of prosperity. In 2008, with its first report, ‘Growing Unequal?’, the OECD alsostarted ringing the alarm bell about pervasive, decades-long rise in income inequality. Finally, the 'Occupy WallStreet’ movement in 2011 broadened public awareness of the debate about widening inequality.

Inequality is not a ‘static’ concept. The UN statesthat the reduction of inequalities is justified by equityconsideration, where equity is defined by ‘a degree ofequality in the living conditions of people, especially interms of income and wealth that society considers

desirable’. The last three words are key as theyimply that what is considered ‘unequal’ varies over timeand is often linked to social factors (such as gender,race, class and culture), as well as lack of social mobilityand factors that lead to persistence.

Moreover, it is a different concept from unfairnessor poverty, although often the three notions are usedas synonyms. From an economic perspective, inequalityhas more to do with the distribution of income andwealth and the lack of access to resources andopportunities to fullfil one’s potential. In contrast,

unfairness requires an element of judgment, and poverty refers more to a lack of resources to maintain basicliving standards and to participate in the normal aspects of life (which could also be a relative, as opposed to an

[ 1 ][ 1 ]

Exhibit 4:Exhibit 4: OECD Lower Incomes Lagging

Note: th e lin es rep resen t h ou seh o ld size-ad ju sted d isposab le

in come.


[ 2 ][ 2 ] [ 3 ][ 3 ]


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absolute, concept, varying with time and social factors). Putting it differently, inequality has to do with thedifferences in living standards and not with their absolute levels.

Inequality of income is also different from wealth inequality. This difference is quite important whenmeasuring inequality and could lead to different conclusions depending on the metrics used.

• Income is a ‘flow' variable that remunerates the factors of production (labour and capital) over a period oftime. In the case of labour, as well as wages and salaries, it includes income from financial assets (dividends andinterest rates), rents from properties, and welfare benefits, in the countries where they exist, during a set period.

• Wealth is a stock concept, which measures the value of all assets owned by an individual, a company orcountry (whether tangible or intangible). It accumulates over time and can generate income (for example rents,stock dividends or interest paid to owners of capital).

Often, but not always, the distribution of income and wealth is correlated.

Measuring inequality is difficult. For a start, most measures typically focus on monetary variables since non-money income or wealth (such as job satisfaction or the benefit that an individual may get from certain serviceslike education or housing, for example) cannot be measured easily and may not be observable. Also, the timeframe over which income or wealth is measured can lead to different conclusions. This is important, asinequality measures typically take a snapshot of a distribution but do not take into account lifetime prospects.

The Gini CoefficientThe Gini Coefficient

Graphically, the Gini coefficient can be easily represented by the area between the Lorenz curve and theline of equality.

The Lorenz curve maps the cumulative income share against the distribution of the population. If eachindividual had the same income, or total equality, the income distribution curve would be the straightline in the graph – the line of total equality. The Gini coefficient is calculated as the area A divided by thesum of areas A and B. If income is distributed completely equally, then the Lorenz curve and the line oftotal equality are merged and the Gini coefficient is zero. If one individual receives all the income, theLorenz curve would pass through the points (0,0), (100,0) and (100,100), and the surfaces A and B wouldbe similar, leading to a value of one for the Gini-coefficient.

And, whose income do you measure? This raises the question of how to define the income unit (per capita,per household?) and how to compare units of different sizes. For example, if a man is married with two childrenand his only source of income is $20,000 per year, his households could be treated as a unit (and therefore the


9

income would be shared among the other members of the family), or he could be treated as a separate unit (inwhich case his wife and children would have no income and boost measured inequality). Usually the narrower

the definition of the income unit, the larger the measured inequality. Furthermore, the timespan over whichinequality is measured is important for the conclusions drawn.

In terms of metrics, the most commonly used measure is the Gini coefficient, which varies between 0(complete equality) and 1 (complete inequality). In simple terms, the coefficient compares the income or wealthdistribution of a population, a country or a region, to a perfectly equal distribution where every citizen has equal

wealth (see box below).

The Gini coefficient is very popular, because it is a synthetic indicator and is quite easy to understand;however, it has limits. For example, two different income distributions can have the same Gini coefficient (seeExhibit 5Exhibit 5).

Alternatively, two same income distributions can have different Gini coefficients depending on how the sampleis grouped (see Exhibit 6Exhibit 6).

Moreover, it is very sensitive to outliers and it is not additive across groups (i.e. the total Gini of a society is notequal to the sum of its sub-groups). Finally, it is calculated sampling the income of individuals at different pointsof their lives (for example, a student's negative income for an education loan is different from the negativeincome of an older unemployed individual).

For this reason, the Gini coefficient is often complemented or substituted by alternative measures,

[ 4 ][ 4 ]

[ 5 ][ 5 ]

Exhibit 5:Exhibit 5: Different income distributions with the same Gini Index

Household number Country A Annual Income ($) Country B Annual Income ($)

1 20,000 9,000

2 30,000 40,000

3 40,000 48,000

4 50,000 48,000

5 60,000 55,000

Total Income $200,000 $200,000

Country's Gini Index 0.2 0.2

Sou rce: FAO

Exhibit 6:Exhibit 6: Same income distributions but different Gini Index

Household number Country A Annual Income ($) Household combined number Country B Annual Income ($)

1 20,000 1 2 50,000

2 30,000

3 40,000 3 4 90,000

4 50,000

5 60,000 5 6 130,000

6 70,000

7 80,000 7 8 170,000

8 90,000

9 100,000 9 10 270,000

10 110,000

Total Income $710,000 $710,000

Country's Gini Index 0.303 0.293

Sou rce: FAO


10

such as the percentile dispersion ratio, which measures the share of income/wealth of the poorest 'x'%. Thisratio is calculated by dividing the top percentile, for example the average income of the richest 10% of thepopulation, by the bottom one – in more equal societies, this ratio would be one or below, meaning that the top10% does not receive a larger share of the national income than the bottom 10%. Other common metrics arethe Theil and the Atkinson indices, for example.

The control for age is particularly important when assessing the distribution of income and wealth.Consider a hypothetical society where everyone earns the same and saves 10% towards retirement: the youngpeople would have no wealth (because they would be at the start of their working careers), the older cohortwould have little wealth too because they would no longer be saving and the people close to retirement agewould be relatively wealthy and about to start dissaving. So the distribution would be highly unequal, even if thelifetime income would be exactly the same for everyone, because it is a cross-snapshot at a given point in time.


11

Has Inequality Gone Up or Down?Has Inequality Gone Up or Down?

The difficulty in defining and measuring inequality explains why there is ambiguity in research oninequality, as different conclusions can be drawn depending on the metrics used and the sample examined.

Global inequality appears to be falling. When making international comparisons, countries’ levels ofprosperity are typically measured by GDP per capita (PPP). On this count, the world has been heading in a betterdirection over the last 20 years: not only has the level of world GDP more than doubled (from $6,167 to in 1994to $14,393), meaning that global wealth has increased, but there has also been a degree of convergence amongcountry incomes per capita.

The world is wealthier… In 2014, global GDP percapita was 2.4 above the level of the mid-1990s, withabove average gains for middle income countries and inmany developing countries, especially in the East Asiaand Pacific regions, as well as those in Europe andCentral Asia (see Exhibit 7Exhibit 7). Importantly, the high-income countries’ GDP per capita (PPP) was 26.5 timesthat of low-income countries in the mid-1990s, and in2014 the ratio had shrunk to 25.3. At the same time, theratio of high-to-middle income countries narrowed

from 6.8 to 4.2.

…and between-country income has convergedsomewhat. There has been a decrease in the globalGini coefficient from the late 1980s from 72 points to

67 in 2011 , largely driven by the fast growth rates ofChina and India, and between 2008 and 2011, alsobecause of lacklustre economic growth in rich countriesin recent years. The average real per capita income,calculated from Chinese household surveys, hasincreased by 45% between 2008 and 2011; in India –

the increase was by 11%. Life expectancy has risenglobally too, especially in low-income countries sincethe beginning of the millennium, reducing the gap withricher countries (see Exhibit 8Exhibit 8).

Income inequality within many countries is increasingIncome inequality within many countries is increasing

Within many developed and developing countries though, the distribution of income betweenhouseholds is more unequal now than it was two decades ago... In emerging economies, although levelsof inequality tend to be higher than in most OECD countries, trends have been mixed in recent decades, withevidence of narrowing income gaps in most Latin American countries since the late 1990s, and signs of a halt in

the rise in some other countries, including China and Russia, since the mid-2000s (see Exhibit 9Exhibit 9).

...especially within the OECD (see Exhibit Exhibit 11 , front page). Compared to 1985, in 2011, real household incomewas higher across different percentiles of the income distribution. This implies that even the less well-offwere better off compared to the mid- 1980s.

Exhibit 7:Exhibit 7: Global GDP Per Capita Has More ThanDoubled Since the Mid-1990s

Ratio betw een G DP per cap ita (PPP) in 2014 an d in 1994.

Sou rce: W orld B an k , Morgan Stan ley Research

[ 6 ][ 6 ]

Exhibit 8:Exhibit 8: High-Low Income Country LifeExpectancy Gap Shrinking

Sou rce: W orld B an k , Morgan Stan ley Research

[ 7 ][ 7 ]

[ 8 ][ 8 ]

[ 9 ][ 9 ]


12

However, the gap between the top and the bottom10% has widened persistently over that time frame(see Exhibit 10Exhibit 10 ), and even after the Great Recession,when both categories experienced a contraction of realincome. The same is true of the gap between the top10% and the bottom 40%. For OECD members, above-average gains perhaps surprisingly were experienced inSweden, which is typically known for its state incomeredistribution policies, followed by the United Statesand New Zealand. In the euro area, the countries whichstand out are Finland and Germany.

Sweden tops the OECD list of countries whereincome inequality has risen the most (see Exhibit 11Exhibit 11). The case of Sweden is interesting because despiteremaining one of the OECD's most equal countries, ithas experienced one of the largest increases in income

inequality since the mid-1980s (see Exhibit 12Exhibit 12). According to the OECD, the average income of the top10% of income earners relative to the bottom 10% roseto 6.3 times, up from 5.7 times in 2007 and 4 timesduring much of the 1990s.

The rise stems largely from widening gaps in marketincome sources: gross earnings, self-employmentincome and capital income have become moreunequally distributed. At the same time, the notoriouslygenerous welfare system reduced benefits, withtransfer to households falling from 27% in 1995 to 16%in 2008.

Capital income, in particular, played an importantrole in Sweden as it became more concentrated over

time, explaining 13% of total income inequality (up from 8% in the mid-1980s). At the same time, a downwardtrend in redistribution was also observed with transfers as a share of household income dropping from 27% in1995 to 16% in 2008, despite remaining well above the OECD average. These findings were echoed by the

Institute of Economic Affairs.

The US is the country where real disposable income expanded the least before the Great Recession.This is true on average across the population and for the bottom 10%, when compared with other largeEuropean countries. Prior to the Great Recession (1980-2008), average US households' real disposable income

Exhibit 9:Exhibit 9: Inequality Has Gone up in Some Bricsand Down in Others

Sou rce: W orld B an k ,

Exhibit 10:Exhibit 10: Bottom OECD 10% Household RealIncome Lagging

Th e p re-crisis period is f rom th e mid-1980s to 2007-08. Th e post-cris is

period is f rom 2007-08 to 2012.


[ 10 ][ 10 ]

[ 11 ][ 11 ]

Exhibit 11:Exhibit 11: Sweden Had the Largest InequalityChange since the mid-1980s...

Source: OECD, Morgan Stanley Research

Exhibit 12:Exhibit 12: ...But Its Inequality Level Is StillRelatively Low



13

rose by 0.9%, compared to 0.1% for the bottom decile. Perhaps less appreciated is the fact that in Germanythe pattern has been similar,(see Exhibit 13Exhibit 13) and in contrast with that of France and Italy. Post the GreatRecession, the bottom 10% experienced real income contractions in all countries bar Germany (where realincome stagnated), with the largest contraction in Spain.

Looking at the top 10%, real household disposable income rose in all countries before the crisis, andfell in only three after the crisis (with the largest contraction in Spain, followed by Italy and to a lesser extentthe U.K, see Exhibit 14Exhibit 14). Interestingly, in France it rose before the crisis but even more so after, as capital incomeincreased as a share of total income more than in other countries.

Wealth inequality is greater than income inequalityWealth inequality is greater than income inequality

Wealth inequality is bigger than income inequality notonly because financial and real estate assets areunevenly distributed but also because manyaccrue to top both income and wealth ofhouseholds (see Exhibit 15Exhibit 15). Moreover, it can beinherited, a factor that can 'self-perpetuate' wealthconcentration. Based on the 2010 household financialcountry surveys, on average in the EU, the share ofhouseholds that have inherited wealth is 33%, with thelowest share in Luxembourg (28.9%) and the highest inCyprus (44%).

In the US, inheritances play a major role in the wealthdistribution accounting for an estimated one-quarter of

total household wealth accumulation. On averageroughly 30% of households receive wealth transfersthat account for close to 40% of their net worth near

time of death.

Globally, most of the people in the ‘eye-catching’ top 1% are still in the OECD: one half of them areAmericans (the richest 11% of Americans). From other rich and relatively populous countries (Germany, France,

Japan, UK) 4-5% of their population belong to the global top 1%.

Among rich countries, the top 1% of households accounts for 18% of total OECD household wealth,and the top 10% for 50%. By contrast, the bottom 60% owns 13% and the bottom of 40% accounts for only3% .

Exhibit 13:Exhibit 13: Stagnant Bottom 10% Household RealDisp. Income in US, Germany and Italy Pre-Crisis

The pre-crisis period is from the mid 1980s to 2007-2008, the post-crisis is from 2007-2008 to 2012. Annual averages.Source: OECD, Morgan Stanley Research

Exhibit 14:Exhibit 14: Top 10% Household Real Disp.Income Rose in US, Germany and France AlsoPost Crisis

The pre-crisis period is from the mid 1980s to 2007-2008, the post-crisis is from 2007-2008 to 2012. Annual averages. Source: OECD, Morgan Stanley Research

Exhibit 15:Exhibit 15: Wealth Disparity Bigger Than IncomeDisparity

Hou seh o ld size ad ju sted d isposab le in come an d n ew p rivate

h ou seh o ld w ealth . Th e O ECD average in clu des 17 cou n tries.


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[ 13 ][ 13 ]

[ 14 ][ 14 ]


14

Mean net wealth is 2.5 times larger than median net wealth in the OECD, across the 18 countries covered

by the wealth distribution database (see Exhibit 16Exhibit 16). This ratio gives a measure of the ‘skew’ of the wealthdistribution and is better suited than conventional measures such as the Gini coefficient because a largeproportion of households have zero or negative wealth. By comparison, the equivalent ratio of mean versusmedian income is between 1.5-2 in the case of household income for most OECD members for which data areavailable but much higher in the US, the Netherlands, Austria and Germany.

Wealth stored in financial assets is much more concentrated than in non-financial assets at the top.Typically the family residence, and real assets in general, are the main source of wealth (~75%) for households.However, on average households in the top 5% have a mean value of financial wealth that is 70 times the valueof those in the bottom 5%, compared to 30 times for non-financial assets. As a result, higher financial assetprices tend to boost wealth of the top 10% comparatively more.

Has quantitative easing played a part in boosting inequalities? The degree of extraordinary stimulus thatcentral banks in industrialized countries have put in place since 2008 – both through conventional tools, vialower short-term interest rates, and unconventional, through widescale asset purchases – raised a range of assetprices, benefiting their holders, and lowered yields, benefiting borrowers at the expense of savers. But lowinterest rates have also helped highly indebted households. Thus, the impact of Q/E on inequality is not clear cut.Faced with increasing criticism that Q/E has been directing more money to the wealthy, central bankers havealso reacted along the same lines, stressing that in the absence of Q/E the slump could have been worse: therecould have been a bigger drop in wages than employees would otherwise have experienced and more joblosses, because economic growth would have been lower and unemployment higher. Former Fed Chairman BenBernanke, whilst acknowledging that monetary policy certainly affects the distribution of income and wealth,

recently concluded that whether the net effect is an increase or reduction inequality is unclear.

More than just a story of the ‘rich getting richer’. The overall wealth and income gap has widened not justbecause of dynamics at the top end of the distribution but also because the income of those at the low end or inthe middle has stagnated. Typically, in a neoclassical growth model, a higher return on capital investment is onlytemporary because the marginal product of additional units of capital declines (i.e. there are diminishingreturns). However, the ability of technological progress to displace jobs and the ensuing squeeze on wagesprevented a catchup effect from labour. Reduced unionization, an increased disconnect of wages fromproductivity and, finally, globalisation – which reduces demand for rich-country labour - are also among themany reasons that have been brought forward to explain the ‘wage squeeze’. Finally, consumer price deflation,especially of manufactured goods, stimulated households' overspending.

The Burden of DebtThe Burden of Debt

The “let them eat credit” theory. One suggested hypothesis for the steep rise in household borrowing thatpreceded the financial crisis is that low- and middle- income households increased their debt to finance higher

[ 15 ][ 15 ]

Exhibit 16:Exhibit 16: The Highest 'Skew' of the WealthDistribution Is in the US


Exhibit 17:Exhibit 17: Household Debt Is Also High

Source: OECD, Bank of England, Morgan Stanley Research

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consumption in order to "keep up" with higher-income households, with the high leverage not just in the US(see Exhibit 17Exhibit 17). Furthermore, easy accessibility, cheap credit and low inflation allowed low-income earners to

ignore the rapidly growing gap between their stagnant income and mounting debt. At the 2015 WorldEconomic Forum, Bank of England Governor Mark Carney, evoked Rajan's 'let them eat credit' expression to

refer to this rise in debt, which he also attributed to financial innovation, adding that not all of it was good. His comments were echoed by the conclusions of a recent OECD report which maintains that countries with

bigger banking sectors suffer weaker growth and worse inequality.

Whether it was inequality that fuelled a steep rise in debt and what role banks may have played isstill contentious. For example, recent research in the US concluded that there is no causality betweeninequality and debt because it found that (over 2001-2012) low-income households in high-inequality regionsaccumulated less household debt than low-income households in low-inequality regions. Moreover, it suggeststhat the banking sector may have played an important role in the channeling of credit (in other words, banks useapplicants' background information to assess their credit limits and therefore may have given less credit to low-

income earners from high-inequality settings).

The fact remains that close to 10% of OECD households are 'over-indebted', i.e. their debt-to-asset ratiois over 3 times, in 18 countries surveyed, with the largest of these ratios in Norway, Australia and the US (seeExhibit 20Exhibit 20and Exhibit 21Exhibit 21 ). In the euro area, the degree of leverage increases with income levels, and it isrelatively smaller for the bottom 20% (see Exhibit 18Exhibit 18). In contrast, in the US, where income growth hasremained sluggish, low-income households have not been able to deleverage to the same extent as high-income households (see Exhibit 19Exhibit 19).

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Exhibit 18:Exhibit 18: European Household DebtConcentrated Among Middle and HigherIncomes

Source: ECB, Morgan Stanley Research

Exhibit 19:Exhibit 19: Low-Income American HouseholdsStill Highly Leveraged

DTI is Debt to Income.Source: Federal Reserve Board, Morgans Stanley Research

[ 20 ][ 20 ]

Exhibit 20:Exhibit 20: About 10% of OECD Households Are'Over-indebted'


Exhibit 21:Exhibit 21: The Higher the Share of Indebted HHs,the Higher Their Median-to-Income Ratio

HHs in the title means households.Source: OECD, Morgan Stanley Research


16

The End of the Middle Class?The End of the Middle Class?

Faced with stagnant wages, high debt and rising costs, the middle class is eroded by rising inequality.The middle class is an 'ambiguous' social classification, broadly reflecting the ability to lead a comfortable life.

Past generations of middle-class families, emerging from the post-WWII period, could aspire to improvingliving standards, with a reasonably sized house, a good education for their children, dependable pensions and asteady pension income flow. In contrast, middle class aspirations are now running up against the wall of job andretirement insecurity.

Furthermore, cutbacks in public social spending are encouraging the middle class to allocate anincreasing amount of their income to childcare costs... For example, in the OECD, the average cost forchildcare is 11.88% of parental net income (calculated on a family where two parents earn average wage), with

Greece at the lower end of the distribution (4.9%) and the UK at the top (26.6%) (see Exhibit 22Exhibit 22). In turn,high childcare costs have other negative side effects, creating incentives for parents (mostly women) to notreturn to full-time jobs, thus reducing participation rates and lowering potential income.

... and healthcare spending and pension savings. Out-of-pocket spending on healthcare has grown in recentyears, as governments in a number of countries have introduced cost-sharing measures, often means tested,including lower reimbursements for pharmaceuticals, dental treatments and charges for hospital care. In the EUthere were two clear trends before and after the Great Recession: they reduced between 2003 to 2009 from

17.38% to 15.96%, and then started to grow until 2012 when they reached 16.34%. In contrast, they fell to12.3% in 2013 in the US, from 14.3% in 2003. There are significantly different country patterns in the EU,though, as spending rose in Italy, Spain, Portugal Greece and Ireland (countries that were deeply affected by theGreat Recession) and to a lesser extent also in the UK (see Exhibit 23Exhibit 23).

Trends differ by countries but in general, property can no longer be relied upon for wealth creation,in contrast to the past. In 14 out of 23 OECD countries for which data are available, measures of affordability(like house prices relative to income) signal that house ownership is beyond reach for new real estate marketentrants, especially young people.

Even for renters costs are high (see Exhibit Exhibit 2424 ). In the US, between 1999 and 2007, the housing cost burdenrose for both homeowners and renters as home prices and rental costs soared. But between 2007 and 2011, itdropped for homeowners whilst the share of renters with high cost burdens increased. In 2013, more than half

of all renters (52%) still had high cost burdens about twice those of homeowners (26%). The trend is similarin the UK, as renting costs rise ahead of pay and more people are struggling with the high costs of raising adeposit for a mortgage. PWC estimates that in 10 years time, about 25% of those aged 20-39 years (the socalled 'Generation Rent') will own their own home, down from 38% in 2013. House ownership on average

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Exhibit 22:Exhibit 22: Rising Childcare Costs Hitting theMiddle Class

Source: Eurostat, Morgan Stanley Research

Exhibit 23:Exhibit 23: Out-of-Pocket Health ExpendituresAlso Up in Selected EU Countries

Source: OECD, Eurostat, Morgan Stanley Research

[ 24 ][ 24 ]


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across the age classes would continue to go up though, as the generation of the baby boomers extinguishes itsmortgages. ..

The gap in housing accessibility between owners and renters exacerbates the economic dividebetween older and younger age groups because older people are more likely to be homeowners. In 2013,48% of American householders aged 25 to 44 owned their home, compared with 72% of those aged 45 to 64and 78% of those ages 65 and older. In the euro area, 57.1% of those aged 35-44 own a house compared to71% above 65 years.

The gap in housing accessibility between owners and renters exacerbates the economic dividebetween older and younger age groups because older people are more likely to be homeowners. In 2013,48% of American householders aged 25 to 44 owned their home, compared with 72% of those aged 45 to 64and 78% of those ages 65 and older. In the euro area, 57.1% of those aged 35-44 own a house compared to71% above 65 years.

Intergenerational divide has been on the rise for a while. In the mid-1980s the elderly group was the onemost at risk of poverty (see Exhibit 25Exhibit 25); now it is the young people. In the US, since 1974, median personalincome has increased fairly steadily among those aged 65+, in part reflecting the expansion of Social Securityand also a rising share of older Americans in the labor force since 1990s. In contrast, income of those aged 25-34 has fallen and is now even below that of the baby boomers, ages 55-64.

At the same time, as well as reducing other types of social spending (see Exhibit 26Exhibit 26), many governments haveembarked on pension reforms to address prospective pension deficit and have favoured current overfuture pensioners, especially in crisis-hit Southern Europe. The only exception is Italy, which improved theintergenerational burden-sharing by cutting the current and not the future ratio between pensioners' incomeand the income of the active working population. Exhibit 27Exhibit 27 shows the 'benefit ratios' , i.e. the ratio of income ofpensioners divided by the income of active working populations. For pension reforms not to affectintergenerational equity, this ratio should remain unchanged. Instead, the exhibit shows that after the pensionreforms implemented following the Great Recession, in many countries projected benefit ratios for 2060 (i.e.when people who are currently 20 years old will probably retire) have fallen even below the projections madeprior to the recession.

The divide has partly been exacerbated by the Great Recession, with rising job uncertainty, youthunemployment and youth poverty rate increased, accompanied by lower government spending away fromeducation, families and children towards pensioners and unemployed. Cyclically, youth unemployment nowreacts much more strongly to recessions than total unemployment, in part because younger workers

disproportionately are on temporary contracts. Also, it has proven more difficult for young people to get ajob during a recession.

Exhibit 24:Exhibit 24: US Renters Face Higher Costs ThanOwners

Source: US Census Bureau, Morgan Stanley Research

Exhibit 25:Exhibit 25: Intergenerational Divide Rising

The x axis shows age brackets.Source: OECD, Morgan Stanley Research

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This has left a dangerous legacy... Rising levels ofgovernment debt, the cost of state pensions andunfunded public sector pensions, together withincreasing difficulties to access the housing market,imply that prospects for younger generations relative toolder generations will probably deteriorate furthergoing forward.

...adding to intra-generational divide. Not only hasthe share of youth unemployment risen but also theshare of 'NEETS' , a measure of youth inactivity fromyoung people not in employment, education or training,as a percentage of the total number of young people inthe corresponding age group. Young people who areNEETs are at risk of becoming socially excluded, withincome below the poverty-line and without the skills toimprove their economic situation (see Exhibit 28Exhibit 28).

The debate about the struggle of the middle class has taken centre stage in the US, which spends lesson its welfare system than the EU. At a conference on inequality hosted by the Federal Reserve Bank ofBoston in the fall of 2014, Fed Chair Janet Yellen, addressed the challenges facing the middle class. She statedthat “the distribution of income and wealth in the United States has been widening more or less steadily forseveral decades, to a greater extent than in most advanced countries… I think it is appropriate to ask whetherthis trend is compatible with values rooted in our nation's history, among them the high value Americans have

traditionally placed on equality of opportunity.” The Middle Class Task Force established by the US Obamaadministration is emblematic of the centre stage that this issue occupies on the US government's agenda and in

the electoral campaign. The Task Force is a major initiative chaired by the US Vice President and involving awide array of federal agencies, whose goal is to raise the living standards of middle-class, working families inAmerica.

Why are these dynamics important? Because the DM middle class is the group that appears to besuffering the most from increased job polarization. The 'skill-bias' in technological change has dramaticallylowered demand for workers who carry out routine tasks, either cognitive or manual, such as middle-skillproduction and clerical occupations (see also 'Looking Ahead: What to Monitor?' later in the report). In contrast,non-routine high-skill cognitive jobs (such as consulting or financial services) and low-skill non-routine manualjobs (like retail and fast food) have been more in demand .

As a result, the DM middle class is splitting into upper and lower tiers, and, consequently, marketsegments are becoming increasingly bifurcated.The upper segment aspires to higher-quality products and

Exhibit 26:Exhibit 26: Lower EU Governments Spending inHealth and Education

Programme cou n tries are Spain , Po rtu gal an d G reece.

Sou rce: B ru egel, Nation al Sou rces, Morgan Stan ley Research

[ 26 ][ 26 ]

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Exhibit 27:Exhibit 27: Recent Pensions Reforms WillExacerbate Future Intergenerational Divide...

2060 (A) are projections made in 2007, before the Great Recession;2060 (B) are projections made in 2013.Source: Bruegel, EU Commission, Morgan Stanley Research

Exhibit 28:Exhibit 28: ...as Well as Rising Young NEETsLosing the Skills to Improve Their LivingStandards

Source: OECD, Morgans Stanley Research


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will pay a premium for them – for example, organic food and fine products. The lower segment targets 'thebasics', for example 'own label products'. In addition, the same customer may opportunistically shift betweenthe two segments , including young Millennials, who, confronted with relatively lower income and a strongappetite for technology, often resort to 'value' products (especially groceries) to make ends meet. Profit marginsexpand at the high-end of the market and are compressed at the bottom end.

This first effect of this bifurcation is that middle-market products are squeezed out. The analysis givenby Morgan Stanley Equity Research analysts later in this report seems to support this conclusion. For example,the leisure, retail, healthcare, consumer staples and airlines sector are segmenting into high end and low endoffers to their customer bases, moving away from the squeezed middle. In airlines specifically, for example, lowcost carriers have been growing market share. The US domestic market has seen low cost carriers increasemarket share from ~21% in 2015 to ~31% in 2015. However, premium brands are also experiencing growth.Lufthansa, for example, has spent ~€300 mn in premium class upgrades in the past 3 to 4 years.

Overall, companies that show flexibility to take advantage of the market polarisation appear morelikely to survive, our analysts' work suggests. However, to avoid systems which become sclerotic, it thenbecomes extremely important for companies to embrace complexity, in addition to innovation, implying usingthe best supply chains and best process and technology that are necessary for companies to be able to adapt tochanging conditions quickly.

For now, internationally oriented companies are offsetting faltering DM middle-class demand withthe rise of the middle class in developing countries. Indeed, according to World Bank definition of themiddle class as people, (with incomes above PPP$10 per day and less than PPP$50 per day), in 1998 the middle

class accounted for 17% of the world’s population, compared to 29% in 2011. And it is set to rise further to3.2 billion by 2020 and 4.9 billion by 2030 (from 1.8 billion at the end of the last decade), with the bulk ofgrowth coming from Asia which, by 2030, will represent 66% of the global middle-class population and 59% of

middle-class consumption, compared to 28% and 23%, respectively in 2009.

However, for more domestically oriented companies in DM, the boost that came to investment andgrowth from the middle class willingness to 'upscale lifestyles' is dwindling. In other words, keeping upwith the Joneses' is no longer a focus for DM middle class consumers, who are healing from liquidity-assetpoverty.

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How Can Inequality Affect Economic Growth?How Can Inequality Affect Economic Growth?

The relationship is complex and not clear cut: growth can create inequality, but inequality can alsostimulate growth. For example, following the initial work of Kuznets in the mid-1950s, the hypothesis that acertain degree of inequality is inevitably associated with the early stages of new economic development of acountry (as it undergoes industrialisation) has been widely accepted. The same could be valid now as richercountries transition from manufacturing-based to services-based economies (with increasing digitalisation). Thehypothesis maintains that in the initial stages of development, investment opportunities increase for those whohave the capital to invest and for the successful risk-taker innovators. Moreover, labor shifts from less-attractiveto more-attractive sectors/regions (for example from rural to urban areas) keep wage growth low, wideningincome gaps. However, eventually, the benefits of rapid growth become more widespread, and inequalitydecreases.

At the same time, market economies rely on price mechanism to allocate resources, and thereforeinequality can act as an incentive to specialise in the sectors that yield the highest return. Inequality cancreate incentives for entrepreneurship, open opportunities and stimulate investments. Importantly, it fuelsinnovation and could be a source for social mobility, if it works as a spur to take risks, to go into highereducation, and more broadly, to work harder. So, in this respect it is positive for growth.

An ambiguous area is the effect on growth via the link between uneven income and wealthdistribution and aggregate saving. One school of thought suggests that income inequality is associated witha higher level of savings, given a rising marginal propensity to save as income increases. According to this lineof thinking, therefore, inequality is a key reason for lower investment and low growth, since the wage share innational income declines and, with it, scope for consumers to drive growth. However, in recent years, moreempirical literature has emerged that does not support the idea that income inequality has any systematic effect

on aggregate saving. Moreover, it can be argued that even if savings go up, more capital becomes availableto finance investment and therefore the optimal mix between investment and consumption depends also on thevalue of worthy projects available to finance. How to steer to determine this mix depends also on policy optionsthat are beyond the remit of this report .

Pernicious When PersistentPernicious When Persistent

When inequality becomes entrenched and persistent though, it can lead to poorer economicperformance. via several channels Since the Great Recession, a flurry of literature, including from the IMFand the OECD, has highlighted the negative consequences that rising and persistent inequality could have oneconomic growth. The wide resonance of Thomas Piketty’s ‘Capital in the Twenty-First Century’ (arguing in anutshell that in an economy where the rate of return on capital outstrips the rate of growth, wealth will alwaysgrow faster than income) is symptomatic of the sensitivity of the subject but the ensuing debate (amongeconomists and in the media) is also indicative of the fact that the trade-off between inequality and economicgrowth is not clear cut.

Quantifying its economic impact is difficult though. For example, the OECD estimates that incomeinequality has knocked 4.7 percentage points off cumulative economic growth between 1990-2010 in

developed countries. Rising inequality is estimated to have reduced growth by more than 10 pp in NewZealand and Mexico, 9 points in the UK, Finland and Norway and between 6-7 points in the US, Italy andSweden. However, these are simulations and, as such, their magnitude needs to be interpreted with

care, as cautioned recently by the German Council of Economic Experts.

Working Through Various ChannelsWorking Through Various Channels

Persistent inequality can affect economic growth negatively through various channels, due to thecomplexity and multi-dimensionality of its drivers. Exhibit 29Exhibit 29 exemplifies a few of these channels, which

[ 30 ][ 30 ]

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we will explore in the rest of the note.

Reduced Investment in Human Capital

The main channel is a reduction in investment, especially in human capital. Inequality can hamper skillsdevelopments among individuals who come from a low-income parental background both in terms of level of

education attained (for examples, years of education) and of its quality (i.e. skill proficiency). The gap inachievement measured by standardised test scores between students from low-income and high-income

background is well documented. . Similarly, there is plenty of research and evidence documenting that

educational attainment is heavily dependent on parents' education (Exhibit 30Exhibit 30 ) . The divide can start in theearly years, because children may miss out on early childhood education deemed crucial to counter the

hindrances that come with being born into disadvantaged households.

Different school attainments affect skills...School performance could be affected not just by the low-incomeparental background but also by segregation (i.e. if children from socioeconomically disadvantaged households

will mix with other disadvantaged children, facing reduced peer pressure to do well). Recently,

neuroscientists even found a link between brain anatomy, academic achievement and family income.

...and life expectancy. Better educated people experience comparatively lower unemployment rates and tendto live longer (see Exhibit Exhibit 3232 and Exhibit Exhibit 3232 ) By bringing improved socioeconomic conditions in which peoplelive and work, higher education promotes the adoption of healthier lifestyles, improves awareness and facilitatesaccess to appropriate health care. By the age of 30, educated men with a university degree (tertiary education) inthe OECD area can expect to live from four to 18 years longer than primary-educated individuals, depending onthe country. The gap is smaller for women (4 years on average), and the country discrepancies are also smaller.

The narrower gender gap is explained by lower risk factors, such as smoking and alcohol use.

Exhibit 29:Exhibit 29: Examples of Channels Through Which Inequality Might Affect Economic Growth Negatively

Sou rce: Morgan Stan ley Research

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Exhibit 30:Exhibit 30: Parents' Background Matters ForEducational Attainment

The data show the pct. of 20-34 year-old in tertiary education byparents' educational attainment. 2012 data.Source: OECD, Morgan Stanley Research

Exhibit 31:Exhibit 31: Large Gaps Between High-Skilled andLow-Skilled Unemployment Rates

Data are for 2013 or latest availableSource: OECD, Morgans Stanley Research

Exhibit 32:Exhibit 32: Life Expectancy of Men with HigherEducation Longer

Data are for 2012Source: OECD, Morgan Stanley Research

Exhibit 33:Exhibit 33: Higher Mortality Rates for UnskilledWorkers (by Type of Disease)

The ratios are based on age-standardized data.Source: ONS, Morgan Stanley Research

Exhibit 34:Exhibit 34: Top Income Earners Can Expect to LiveLonger Than Bottom Ones

Change in average additional life expectancy (in years) at age 55 incohorts born in 1920 and in 1940. Percentiles by income.Source: Barry Bosworth, Brookings Institute, Morgan StanleyResearch


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Lower Life Expectancy and Poorer Health

Poorer health of low-income individuals couldalso reduce productivity...Low-income earners,around the world, have the worst health (see Exhibit Exhibit 3333and Exhibit Exhibit 3434 ). Within countries, the evidence showsthat in general the lower an individual’s socioeconomicposition, the worse their health. There is a socialgradient in health that runs from top to bottom of the

socioeconomic spectrum. There is vast economicevidence suggesting that life expectancy and mortalityrates are higher/lower for poorer people. HIVprevalence, and risk factors such as obesity and tobaccouse, are also greater (see Exhibit 35Exhibit 35). The most commonlarge inequality between high and low income groups isperhaps unmet dental care needs, which could haveside effects in other parts of the body, including

diabetes and heart diseases.

...via increased mortality, lost productivity at workand reducing the workforce (see 'Sustainablesee 'SustainableEconomics: The Bitter Aftertaste of Sugar' March 18,Economics: The Bitter Aftertaste of Sugar' March 18,2015)2015). For example, in the US, at the age of 55, all menwho were born in 1940 can expect to live longer thanthose who were born in 1920. However, the top 10% byincome who were born in 1940 can expect to live evenlonger (by about 4 years) than the bottom 10%. Forwomen, the results are even starker because whilst thetop 50% can expect to live longer than the women who

were born in 1920, life expectancy for the bottom 50% has decreased, with the largest contraction for thebottom 10% as large as 2 years.

Rising Student Debt Shrinking the Net Return on Education?

But there are also negative consequences for those with higher educational attainment... The numberof students who complete tertiary education (university graduates) who cannot find a job at all or not onecommensurate to their skills is increasing in DM. In the OECD, 40% of 23-34 years old have a tertiaryeducational attainment compared with only 26% in 2000 (and well above the 25% of 55-64 years old). And yettheir employment rate dropped from 85% in 2000 to 82% in 2013, a contraction exacerbated by the GreatRecession, which is expected to have long-lasting impact on the students who graduated at that time. Indeed,the effect from adverse labor market conditions are larger and can be persistent for individuals in the first year

of their careers compared to those with a few years of experience.

Indeed, there is evidence that ‘unlucky’ graduates who end their education career during adversemacroeconomic conditions suffer persistent earnings declines, because they start working, if at all, forlower paying employers before progressing through a gradual process of mobility towards better higher-paying

firms. .

Graduates face considerable more uncertainty about the ‘net’ return for their education because ofincreasing debt at graduation. Spending on higher education is increasing: across the OECD it rose from1.3% of GDP in 2000 to 1.6% in 2013. And the American model, where the private sector provides a large part ofthe education and individuals pay for most of their tuition, is spreading among rich countries. As a result, in

Exhibit 35:Exhibit 35: The Health Inequality Spectrum

Sou rce: Morgan Stan ley Research based on Pu b lic Health En g lan d

[ 40 ][ 40 ]

[ 41 ][ 41 ]

[ 42 ][ 42 ]

[ 43 ][ 43 ]


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http://www.collectivites-locales.gouv.fr/

several OECD members, most students are in debt at graduation: the highest proportion is in the US (see USEconomics: Inequality and ConsumptionInequality and Consumption, September 22, 2014) where two out of three graduates have a debtloan of an average $25,400, or 46.5% of GDP per capita (and where total student debt reached $1.1 trillion in2013). In contrast, in Turkey one in five students at graduation has an average debt of $5,200 (26.5% of GDP percapita). Even in countries that do not charge tuition fees, student debt levels can be high (as in the case ofSweden with an average $20,000 and Norway with $25,000, ~45% and ~38% of GDP pc, respectively) becauseof elevated living expenses. In Nordic countries, income is also generally lower and taxes higher than incountries with high tuition fees.

The Rise of Underemployment

The mismatch in labor skills has importantimplications for the structure of the labor market.To start with, lower skill acquisition by low-incomepeople creates an imbalance with skill demand resultingin comparatively higher unemployment and loweremployment rates. In the OECD, the level ofunemployment of people with low educationattainment (below upper secondary education) is 13.7%,compared with 8.7% for those with ‘upper or post-secondary educations’ and 5.3% for those with tertiarylevel, implying that people with low educationattainment are almost 3 times more likely to beunemployed than those with higher education levels.Exhibit 36Exhibit 36shows that employment rates of people withhigher education attainments are similar, yet there is

considerable difference across countries in employment rates of low-education attainers.

Moreover, it leads to underemployment, via involuntary part-time work or underutilization of skills,or a reduction of the labor force (because of a rise of ‘discouraged workers’ who stop seeking for a job) anda subsequent underuse of economic capacity, and potential growth (see Exhibit Exhibit 3737 and Exhibit Exhibit 3838 ). Eurostatestimates that in the EU28, in addition to an unemployment rate of 9.5%, 4.2% of the labor force isunderemployed, 3.7% is available but not seeking work and another 1% is seeking work but not immediatelyavailable. That’s a total of an extra ~9% of the labor force. In the US, in addition to the 5.0% of the populationthat is unemployed, we estimate an additional 4.8% of the population belongs to the "shadow labor" or

underemployed population. The problem is even more pressing when looking at the youth who are neitherin education or employment (NEET) whose share in the OECD has risen from 17.5% in 2005 to 18.2% in 2013.

Exhibit 36:Exhibit 36: Employment Rates For Low SkilledWorkers Vary Considerably by Country


[ 44 ][ 44 ]

Exhibit 37:Exhibit 37: Involuntary Part Time Rising EvenBefore the Great Recession...


Exhibit 38:Exhibit 38: ...with the Largest Gains (and Levels)in South European Countries

Source: OECD, Morgans Stanley Research


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Credit Over Expansion

Finally, greater income inequality resulting from credit overexpansion can hit economic activity. Of allthe credit channels to the private sector, according to the OECD it is household credit that potentially has thelargest dampening impact on economic growth (see How to restore a healthy financial sector that supportsHow to restore a healthy financial sector that supportslong-lasting, inclusive growth?', OECDlong-lasting, inclusive growth?', OECD). Indeed, an increase in private credit or stock market capitalization by10% of GDP in a sample of OECD countries could reduce real GDP growth per capita by more than 0.5%.

Consequences beyond GDPConsequences beyond GDP

The negative impact of inequality could be evenbroader if we also include relational andsubjective well-being in the definition ofprosperity. The ‘beyond GDP’ initiative officiallylaunched by Eurostat in 2007, to foster the developingof indicators which are more inclusive of environmentaland social aspects of progress, added impetus to workin this area, complementing the World Bank's HumanDevelopment Index (HDI) and Gross National HappinessIndex (NHI) and the OECD’s Better Life Index, to name afew. Indeed, this year’s Nobel Laureate Angus Deatonhas shown that there is a positive correlation betweeneconomic prosperity (still measured by GDP per capita)and life satisfaction. Research has also shown that thecorrelation is not high just across countries but alsowithin countries. We also find that the OECD happinessindices rise when income inequality (measured by theGini coefficients) drops (see Exhibit 39Exhibit 39).

The role of perceptionThe role of perception

Perceived inequality may differ from actual inequality. Values and norms differ not only across countriesbut also within a society. For example, in some countries where statistics indicate that inequality is high (such asin the US), surveys show that respondents have generally felt inequality is not too bad, at least until recently, andthat there is plenty of opportunity. In contrast, in other countries (such as France) respondents feel that

inequality is extensive, even if statistics indicate the opposite.

In general, surveys indicate that people in Europe tend to underestimate the proportion of middle-income earners and to overestimate the proportion of low-income earners. Indeed, econometricevidence suggests that inequality perception on a personal level is driven more by political attitudes and'subjective' evaluation of the personal situation of the respondents, than by 'objective' socio-economic factors

related to education and the labor market, for example. Within the EU, the share of people most dissatisfiedwith the overall level of inequality is over 70% in Latvia, Hungary, Slovenia, Estonia, Bulgaria, Greece and Latvia;in contrast, it is below 40% in Denmark, Netherlands, Austria, Italy and Malta (Eurobarometer).

Voters Giving up Loyalty for 'Voice' or 'Exit'Voters Giving up Loyalty for 'Voice' or 'Exit'

The link between actual and perceived inequality is crucial in understanding voting behaviour . If theperceived level of inequalities exceed levels of tolerance, there are several channels thorough which economic

growth can be harmed:

1) rent-seeking or illegal activities (the latter could still add to GDP growth but would be accompanied by an

Exhibit 39:Exhibit 39: Lower Inequality Measures Pointingto Somewhat More 'Happiness'

Th e G in i coeff icien t varies betw een 0 (perfect equ ality) an d 1 (perfect

in equ ality). MS ca lcu lation s based on 32 O ECD cou n tries.


[ 45 ][ 45 ]

[ 46 ][ 46 ]

[ 47 ][ 47 ]


26

http://www.oecd.org/eco/How-to-restore-a-healthy-financial-sector-that-supports-long-lasting-inclusive-growth.pdf

increase in crime). In turn, these activities can threaten property rights, thus hindering investment and growth;

2) policy errors, ranging from higher taxation which reduces the rate of accumulation/investment of capitaland therefore growth, to increased market regulation and protectionism (via the erection of trade barriers),which could hinder globalization)

3) voters' apathy could increase, meaning loss of trust in the institutions and the risk that the vote of a fewcould decide for large numbers. Indeed, voter turnout has declined in around two-thirds of OECD countries,

compared to 2007 levels; moreover, support for anti-establishment party alternatives could rise (seeEuropean Economics: Politics and its Discontents, July 20, 2015European Economics: Politics and its Discontents, July 20, 2015).

4) finally, radical demand for policy changes could rapidly lead to violence and illegal seizures of power,which hinders investment opportunities.

In Europe, the political risk premium is on the riseagain (see European Economic: Politics and itsEuropean Economic: Politics and itsDiscontents, July 20, 2015Discontents, July 20, 2015). The escalation of the Greekcrisis during the summer, and its handling by the Syrizagovernment, has taken some steam temporarily offprotest parties elsewhere in Europe compared to early2015. However, the upsurge of the migration crisismight rekindle support for anti-establishment parties tothe left and to the right, which promise to give a voiceand representation to calls for less globalization, lessmigration, more protection of national jobs.

In the US, the issues of class, race and immigrationare expected to play a major role in the dialogueleading up to the election of a new President nextyear. Such issues already have captured a growingshare of the national consciousness, and the Republican

and Democratic political parties are split along expected lines. The financial crisis sparked several protests inmajor cities across the country and in 2011, conflicts between rich and poor ranked ahead of the three otherpotential sources of group tension: immigration, race or age, according to Pew Research Center.

However, over the past year, a growing number of Americans view racism as a big problem in society andseveral groups have staged demonstrations in various cities, as well as on college campuses. According to Pew,59% of Americans say the country needs to continue making changes to achieve racial equality while 32% saythe country has made the changes needed. A year ago, public opinion was much more divided on the questionwith 49% stating that changes were needed and 46% satisfied with the status quo. Public attitudes towardsimmigrants have been growing more positive since the mid-1990s according to Pew Research Center, thoughrecent terror attacks abroad and the migration crisis have raised caution.

In the meantime, according to a Gallup survey, at the end of last year, support for the independent parties (43%)was at a record high and exceeded that for the Republicans (26%) and the Democrats (30%).

[ 48 ][ 48 ]

Exhibit 40:Exhibit 40: Fringe Parties Benefit from RisingInequalities

Sou rce: Variou s n ation al sou rces, Morgan Stan ley Research


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Looking Ahead: What to MonitorLooking Ahead: What to Monitor

Detecting the tipping points beyond which inequality becomes disruptive is difficult, because the

drivers of inequality are complex and interlaced. The unrest which accompanied the worsening of theGreek debt crisis and the political crisis in Portugal, where it is proving difficult to form a government, seemsymptomatic of long-standing economic problems that have accumulated over time, including highunemployment and worsening living standards.

Following labor market developments is important in order to take the pulse of wage andunemployment dynamics, especially paying attention to secondary statistics, like the level ofunderemployment and 'unintended' part time, that tend to attract less market attention than the headlinefigures.

Three long-term challenges we believe deserve attention are:

While these represent opportunities for growth, they also have the potential of being destabilizers formarkets, if they either contribute to or are perceived as contributing to widening economic inequalities.

Challenge 1: OutsourcingChallenge 1: Outsourcing

The rise of the shared economy, increasinglyreferred to as 'the Uberisation of the economy',has added a new dimension to outsourcing (see

Exhibit Exhibit 4242 ). 'Uberisation' effectively describesoutsourcing that has been enhanced by the use oftechnology. Historically, the main point of contentionwith outsourcing has been the creation of low-paid jobs,especially in manufacturing and via offshoring,particularly the contracting of cheap labor fromdeveloping countries. Recently, the rise of the peer-to-peer economy also has introduced the possibility tooutsource services domestically, using platforms offreelancers. With the help of technology, the shifttowards 'atypical' contracts has therefore reached a newlevel.

Uberisation is bringing about major changes totraditional models of employment. By facilitatingthe matching of labour demand-supply, Uberisationcould conceivably help ease labor market rigidities,with additional benefits. For example, it wouldreduce prices (and possibly even improve quality) and it could help bridge the gap between the skill demand-supply, with remarkable socio-economic advantages, by stimulating a more productive and engaged workforce.It could also reduce unemployment and underemployment and increase accountability (because of customerfeedback). Finally, it could boost competition among the 'old players' in the sector to protect market share.

The phenomenon is not limited to lower-skill jobs. In the US, the Upwork platform comprises 2.5 million

[ 49 ][ 49 ]

outsourcing

migration

technological progress

Exhibit 41:Exhibit 41: The peer-to-peer economy has addeda new dimension to outsourcing

Sou rce: w w w .Sh u tterstock .com

[ 50 ][ 50 ]


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freelancers who offer professional services (such as legal, consulting, web designing). According to a study bythe Freelancers Union, US freelancers are about 53 millions (i.e. one in three active workers, and this ratio couldrise to one in two by 2020).

But an increasing shift from salaried to self-employed jobs can also be a source of tensions, as itintroduces a new level of uncertainty for the workforce, which, in turn, becomes less protected, more precariousand with more difficulty in accessing to credit. Indeed, freelancers frequently lament long delays in collectingpayments. Workers would also lack ongoing training and continuing professional development. So, in thisrespect, uberisation could exacerbate inequalities.

Challenge 2: MigrationChallenge 2: Migration

The escalation of the refugee crisis in Europe has brought the issue of migration to the attention ofpolicymakers and the general public in a dramatic fashion. Asylum seekers fleeing from war-torncountries are fewer than 'economic migrants' who seek jobs and better lives. Yet, the crisis has evolved soquickly that European leaders have been struggling to deal with it. German Finance Minister Schauble recentlycompared migration to a 'rendezvous with globalisation' or an 'avalanche', calling for co-ordinated action at theEuropean level. Indeed, according to the latest Eurobarometer, it currently tops public opinion ranking of themain economic challenges facing the EU, up from fourth in the autumn of 2014 (Exhibit 42Exhibit 42).

From a long-term perspective, migration is apositive in ageing DM countries on many fronts.The old age dependency ratio, which measures theshare of 65+ (currently defining old age) over thosebetween 15-64 (working age) will rise rapidly in manyEuropean countries (especially Germany and Italy) andalso in the U.S. over the next 20 years, with furtherincreases thereafter. Even allowing for the fact that thetrend may not be steep, because retirement ages areincreasing and old-age health is improving, migrationwould still be needed to help mitigate this surge: itwould help meet labor demand (including services toelderly people); fill in skill gaps; boost activity levels; andbring innovation and cultural diversity.

Exhibit 42:Exhibit 42: Immigration Tops the PublicOpinion's Ranking of the Main EU Challenges

Respon ses to th e qu estion 'W h at do you th in k are th e tw o most

importan t issu es facin g th e EU at th e momen t?"

Sou rce: Eu robarometer, Morgan Stan ley Research

Exhibit 43:Exhibit 43: Little Desire for Increased ImmigrationEven Before the Escalation of the EU Crisis

Responses to the question "Should your country allow more, feweror about the same immigrants'?Source: Pew Research Institute

Exhibit 44:Exhibit 44: Protest Parties Rising Where Share ofLow-Income Countries' Migrants Is High

The data are for 2010-2011 and are percentages.Source: OECD, Morgan Stanley Research


29

Integration is key for long-term benefits but could also boost inequality. Migration impacts both thosewho move in search of better life and job prospects and native populations. If integration proves difficult, theremay be friction between migrants and local people. Moreover, attitudes toward migrants could turn negative ifmigration inflows put pressures on 'shared' public services (like education or health for example). Migrantscould be exploited or can depress wages if they are willing to work for relatively low pay, and they can boostunemployment numbers before they settle in and acquire the skills to be employable. Finally, ease of movementmay facilitate organised crime and people trafficking.

Negative public attitudes towards migration could fuel sentiment for populist, fringe parties. As wenoted earlier, in both the US and in Europe, anti-establishment political forces promise voice and representationto voters' fears over cultural identities, national jobs and domestic security. Protest parties gained traction, evenbefore the escalation of the migrant crisis in the EU, in countries (like Greece, Spain, Italy, France and the US)that have a relatively higher share of immigrants from low-income countries (see Exhibit 43Exhibit 43 Exhibit 44Exhibit 44).Moreover, support for German Chancellor Angel Merkel's CDU party slipped to 35% in early November, close tothe lowest level since the height of the euro crisis in 2012, following Chancellor's Merkel 's announcement inearly September that Germany would not place a limit on the number of Syrian asylum-seekers it would accept.

Challenge 3: TechnologyChallenge 3: Technology

The ‘skill bias’ attribute has propelled technological change at the center of the income-distribution

debate. In practice, over the past 30 years, the relative price of skilled labor, especially in information andcommunication (ICT) technologies and problem solving (PS), has increased significantly relative to that ofunskilled labor, even if the relative supply of college skills tripled over the same period (see Exhibit 45Exhibit 45). A rapiddiffusion of ICT in the work place and a cheapening of the equipment capital are among the tenets that havebeen brought forward to explain this bias.

Technology has transformed the organization ofproduction, polarizing the labor market due tooutsourcing, offshoring and automation, withincreasingly rapid demand for high-skilled knowledgeworkers (for example, software developers) and low-skilled services where jobs are difficult to automate (forexample, home health care workers). In contrast, mid-skilled workers with jobs easily automated (such as dataanalysis, for example) continue to be penalized, amidstthe advances of digitalization (see Morgan Stanley:China - Robotics, Automation for the People, December5, 2012).

But technology has also relieved workers from menialtasks and heavy duty jobs, creating more free time forentertainment. This does not mean that countries whichare more technologically advanced are necessarily moreequal. Indeed, countries with similar level of inequality can have different levels of technological advancementand vice versa.

However, there are no compelling reasons to expect that technological change will always be skill-

biased. Indeed, with job opportunities arising in new sectors, the labor force adapts and acquires new skillsets over time. Moreover, if replacing skilled workers becomes more profitable, new technologies may attemptto replace them. For example, medical diagnosis might be done by artificial online devices, or online educationcould make education cheaper. Furthermore, as digital products become more use friendly, they may increasethe returns to the low-skill users, via increasing accessibility to services and opportunities.

We are in the middle of a transition phase though and in the meantime inequality may continue toincrease in the short run. Therefore, even leaving aside the debate about the need for and appropriateness of

[ 51 ][ 51 ]

Exhibit 45:Exhibit 45: The Wage Skill Bias

Differen ce in sa lary (%) compared to th e g rou p 0 (n o u se, n o sk ills)

ad ju sted fo r edu cation an d w age (25-64 year-o lds). Data po in t w h ich

are n o t statistica lly sign if ican t are n o t sh ow n .


[ 52 ][ 52 ]


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government redistributional policies, which is beyond the remit of this note, the pace at which entry barriers tothe labor market are eased, participation rates are boosted and education enhanced - even to prevent adepreciation of human capital among those who already have higher skills - will prove crucial for the future ofinequality.


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Autos: Ripe for disruption, improving equalityAutos: Ripe for disruption, improving equality

Harald C Hendrikse, +44 20 7425-6240Adam Jonas, +1 212 761-1726

Bottom LineBottom Line

Auto companies today make expensive machines that are in operation for 3.5% of the time and areaccessible to only small slivers of the global population, particularly outside of the developed markets.We see technological disruption in the auto industry as poised to improve equality along many lines,including access, affordability and safety.

Autos and Inequality: Shared autonomous cars democratize taxis to the masses and improve access,affordability, safety and sustainability. Today’s automotive business model has not changed materially inmore than 100 years. Companies make expensive machines that are sold to a privileged portion of the world’spopulation. These machines consume finite resources, are only in operation for 3.5% of a 24 hour day and areone of the leading causes of death and injury globally across populations.

There are roughly 1 billion cars and 7.2 billion people on Earth, for a global penetration rate of roughly 14%.Excluding the United States and Europe, vehicle ownership is even more scarce with a penetration of just over7%. To the extent that the automobile provides people with the freedom of personal mobility, this business isstill only accessible to only small slivers of the global population, particularly outside of the developed markets.From this perspective, we argue the starting point of today’s auto industry is one of extreme inequality.

For the 14% of the population that does own a vehicle, the privilege comes at a rather high cost of $1 per mile(excluding time and infrastructure). This is the result of extremely low utilization rates as cars are only inoperation for an average of roughly 1 hour per day. So we have a global invested capital base of around $20trillion (1 billion cars x $20k cars/unit) only used 3.5% of the time, implying that in an average day around $19.2trillion of invested capital goes unused. In our opinion, this is an economic problem that could be improvedsubstantially (by order of magnitude) through the application of autonomous car and connected car technology.Transforming today’s car park into a shared autonomous fleet could, according to our calculations, reduce theper-mile cost of vehicular mobility to levels as low as 50 cents/mile, with potential to approach $25 or 30cents/mile when large portions of vehicle miles travelled can be broken down into seat-miles (higher passengeroccupancy per vehicle mile travelled).

In today’s model of privately owned, human-driven vehicles, the trends of supply, demand and corporate

Exhibit 46:Exhibit 46: China Light Vehicle Sales

Source: IHS, Morgan Stanley Research

Exhibit 47:Exhibit 47: Global Premium Vehicle Sales

Source: IHS, Morgan Stanley Research. Note: Premium includesexotic, luxury, specialist, super luxury


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profitability have followed two main themes: (1) secular growth of penetration of high-end premium brands inthe market; and (2) explosive growth of vehicle penetration in China, taking annual sales in this market fromroughly 1 million units (2% of global demand) to 25 million units (nearly 30% of global demand) in the past 15years.

As we contemplate technological disruption to the traditional business model, we see room forimproving equality in the auto industry along many lines, including access, affordability and safety.Let’s look further into these trends.

Improving access to vehicular mobility for greater portions of the population: Currently, the world’s 1billion car fleet drives an average of 10k miles/year for a total of 10 trillion miles annually at a cost of around$1/mile ($10 trillion in aggregate). In a future of shared mobility, we see the potential for half the number ofcars to drive 60k miles/year for 30 trillion miles at under 50 cents/mile. That’s a 6x improvement in utilization,3x the miles travelled and a 50% reduction in the cost/mile. On our forecasts, by 2030 we estimate quite of bit ofprogress can be made in this direction with 55% of total miles travelled being shared miles.

While we expect the number of cars on the road wouldbe in secular decline, a transformation of the industry toa professionally managed, highly utilized and highlyregulated network would require shorter, morefrequent replacement cycles, resulting in annualproduction volumes that are not too dissimilar totoday’s annual production which will soon approach100 million units annually. In short, we are notconvinced that greater sharing and utilization of assetsnecessarily means substantially lower annual lightvehicle production and lower employment levels in themanufacturing of the machines and the maintenance ofthe global mega-fleet.

From private transport for the privileged few topublic transport for the masses. At a fundamental level, we foresee a nearly complete metamorphosis oftoday’s automobile industry from one of exclusivity, privilege, inefficiency and hazardousness involving mostlyprivate transportation to a vastly more accessible mass transit ecosystem - a shared and far more affordableglobal fleet. We estimate the average cost per mile of global light vehicle travel today stands at nearly$1/mile globally ($0.76/mile in the US according to the AAA). With improved utilization of cars from3.5% (of a 24/hour day) today to 20 or even 25% by 2030, we estimate the cost per mile to the consumercould be as little as $0.25/mile. This estimate is consistent with studies we have seen from the University ofMichigan and the US Department of Transportation at a conference we recently participated in hosted by theUrban Dynamics Institute (UDI) at the Oak Ridge National Laboratory (ORNL).

Enhanced Computer driving could lead to vastly improved accident rates on roads, saving lives. Eachday closer to fully autonomous driving is worth approximately 3,000 lives, according to the WorldHealth Organization. Eliminating human error alone could improve accident rates by 90%, the NationalHighway Transportation Safety Administration suggests. Further improvements in connected car swarms couldpotentially result in near accident free driving. There are many statistics about the unfortunate incidence ofautomobile accidents to passengers and pedestrians. The numbers from the various regulatory agencies like theFHA and the World Health Organization are disturbing. Through the first half of 2015, the United States is onpace to achieve a full year total of 40,000 deaths in motor vehicle accidents, or 1.25 deaths per 100 millionvehicle miles travelled (VMT) or 12.5 deaths per 100,000 population. Additionally, the US sees 2.3 millionserious injuries annually including nearly 300,000 incapacitating injuries annually (FHA). Nearly 1 out of 1,000Americans suffer an incapacitating injury in an automobile accident each year. Globally, the statistics aregrimmer – by order of magnitude – with approximately 1.3 million traffic deaths globally, or more than 3,500deaths per day. Outside of the United States, there are 18.3 traffic deaths per 100 million miles travelled, a ratenearly 15x higher than inside the US. Technology that exists today could greatly improve these statistics.

Exhibit 48:Exhibit 48: Global Vehicle Miles Traveled -Shared vs. Owned



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Shared autonomous electric vehicles improve natural resource sustainability with secondary benefitsto equality over time. Shared cars overcome the greatest disadvantage of today’s electric cars – inferioreconomic payback. Mobile technology and relatively simple software increases driving utilization rates by anorder of magnitude bring taxis and chauffeur services to the masses. This transforms the auto business modelfrom B2C ownership to B2B shared. Enabling each car to drive a far greater number of miles per year helpsamortize the up-front cost of a battery far more rapidly, shrinking the payback. Greater numbers of EVs enableOEMs and contract manufacturers to achieve unprecedented scale economies in battery pack production,yielding further benefits.

To take the point of vehicle utilization vs. EVpayback rates to the extreme, imagine that theowner of a 50KWh battery car used the vehicle for thevery rare Sunday drive of 100 miles/year… the extrapremium paid for the car vs. owning a 40mpg car at$3/gallon gasoline would take 2,778 years to pay off. Tobreak-even vs. an internal combustion engine, such avehicle would have be purchased in the 8th Century BC,at the founding of Rome or during Homer’s epics(ignoring inflation). If the same car were used 1,000miles/year, the breakeven payoff would be 278 years, orpurchased when George Washington was a 5-year-oldlad rambling around the fields in the Colony of Virginia.

On the flipside, if the EV were operated 100,000 miles/year, the payback would be 2.8 years. To achieve thesame 2.8 year payback by only shrinking the battery cost (holding miles driven flat at 10,000/year) wouldrequire $25/KWh… a 90% reduction from Tesla’s current claimed level of cost achievement. $25/KWh wouldrequire technological breakthrough, while 100k miles/year just requires a smarter use of technology thatalready exists.

Eliminating the human from the driving equation could further improve utilization to even higherlevels and efficiency and lower cost per mile. By far the largest cost of today’s ride sharing service is theperson behind the wheel. Replace the driver with a few million lines of code and some commoditized sensors,and the savings could really begin. Shared autonomous fleets address many other problems with today’s EVmodel, such as slower charging time, lower charging station density and range limitations. Out of a totalautonomous taxi fleet of say 10,000 vehicles, perhaps 10% or 20% would be involved in some portion of thecharging process. Please note, we are not considering any material differences in maintenance/repair costsbetween an EV and an ICE vehicle.

Exhibit 49:Exhibit 49: Deaths Per Mile - US vs. Non US

Sou rce: W orld Health O rgan ization , Morgan Stan ley Research


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Exhibit 50:Exhibit 50: EV Payback in years – based on gas prices and fuel efficiency

Payback (years) at various battery cost vs gas price at 40.0 mpg of ICE

BATTERY COST ($/KWH)

GAS PRICE($/GAL)

600 500 400 300 200 100

1.5 400 333.3 266.7 200 133.3 66.7

2 150 125 100 75 50 25

2.5 92.3 76.9 61.5 33.3 30.8 15.4

3 66.7 55.6 44.4 26.1 22.2 11.1

3.5 52.2 43.5 34.8 21.4 17.4 8.7

4 42.9 35.7 28.6 18.2 14.3 7.1

4.5 36.4 30.3 24.2 18.2 12.1 6.1

5 31.6 26.3 21.1 15.8 10.5 5.3

5.5 27.9 23.3 18.6 14 9.3 4.7

6 25 20.8 16.7 12.5 8.3 4.2

6.5 22.6 18.9 15.1 11.3 7.5 3.8

7 20.7 17.2 13.8 10.3 6.9 3.4

7.5 19 15.9 12.7 9.5 6.3 3.2

8 17.6 14.7 11.8 8.8 5.9 2.9

Payback (years) at various battery cost vs mpg of ICE at price at $3.00 gas price

BATTERY COST ($/KWH)

ICEEFFICIENCY

(MPG)

600 500 400 300 200 100

65 185.7 154.8 123.8 92.9 61.9 31

60 150 125 100 75 50 25

55 122.2 101.9 81.5 61.1 40.7 20.4

50 100 83.3 66.7 50 33.3 16.7

45 81.8 68.2 54.5 40.9 27.3 13.6

40 66.7 55.6 44.4 33.3 22.2 11.1

35 53.8 44.9 35.9 26.9 17.9 9

30 42.9 35.7 28.6 21.4 14.3 7.1

25 33.3 27.8 22.2 16.7 11.1 5.6

20 25 20.8 16.7 12.5 8.3 4.2

15 17.6 14.7 11.8 8.8 5.9 2.9

10 11.1 9.3 7.4 5.6 3.7 1.9

5 5.3 4.4 3.5 2.6 1.8 0.9



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Consumer Staples: Bifurcation into low-end and high-end consumersConsumer Staples: Bifurcation into low-end and high-end consumers

Eileen Khoo, +44 20 7425-1838Erik Sjogren, +44 20 7425-3935 Sanath Sudarsan, +44 20 7425-8259Olivier Nicolaï, +44 20 7425-7049Richard Felton, +44 20 7425-5930Matthew Grainger, +1 212 761-8023Dara Mohsenian, +1 212 761-6575

EU FoodEU Food


In EU Food, growing income inequality seems most likely to manifest itself in terms of growthpolarisation, i.e. faster growth at both the premium (incorporating better-for-you / indulgent products)and value ends of the market, with the middle range more squeezed. Whilst all three large-cap EU Foodmanufacturers have strategies in place to address this dynamic, the company we believe to be best-positioned to navigate growing income inequality is Nestle, given its successful track record ofinnovation in driving a dual focus on both premiumisation (e.g. Nespresso) and value (e.g. its ‘PPP’products). Unilever, previously mass-market focused, is increasingly pursuing premiumisation, whileDanone, which has been successful at premiumisation, may need to improve innovation to drive ‘added-value’ and address the price point imbalance in its portfolio, to navigate the widening inequality gap.

Most Favourably Positioned: Nestle

Stronger growth in the number of both higher-income and lower-income consumers globally,combined with a rise in more value-conscious consumers in developed markets, should drive greatermarket polarization in the European Food space, in our view. Nestle arguably has had the most success inaddressing the consumer polarization trend (i.e. growth in demand at the premium and value end of the market,with the middle segment being squeezed). For example, it has achieved positive organic top-line and volumegrowth in developed markets throughout the recession via a strategy that combines: (i) premiumisation (i.e.increasing the range of 'affordable luxury' or 'added-value' products that are sold at higher price points, in orderto improve sales mix – examples include Nespresso and Dolce Gusto in the single-serve coffee space, and itsorganic or 100% natural pet food brands, Merrick and Purina Beyond ) with (ii) growth in entry-level pricedproducts through its PPP ('popularly positioned products') range. PPPs are affordably priced, nutritionallyenhanced, appropriately formatted (e.g. sold in smaller sizes or pack formats) and easily accessible (e.g. indiscount channels) to cater for lower-income consumers globally. Nestlé’s PPP range covers most of itscategories, including beverages, culinary, dairy and confectionery. Nestlé produces PPP versions of major globalbrands including Maggi, Nido and Nescafé. PPPs were originally designed by Nestle to meet the needs of low-income EM consumers, but this has been successfully rolled out across DMs (particularly Europe) to cover allincome levels and provide solutions to changing purchasing patterns. Through PPPs, Nestle gives consumers anopportunity to trade up and down without trading out of its products. PPPs now account for c.14% of Nestle'sannual sales (versus 8% in 2009) and are enjoying low-teens organic growth (c.3x faster than Nestle groupsales).

Unilever has a similar strategy (playing what it has termed the 'price piano', i.e. ensuring that it covers all pricepoints from low-end to premium) and is also now focused on premiumising its products to improve gross


36

margin - from premium ice cream (Talenti Gelato, GROM) and tea (T2) to sensorial fabric conditioner (ComfortPerfume Experts) to compressed deodorants. In Foods, its Savoury Cooking ingredients portfolio (e.g. KnorrStockpot, Baking Bags, Cubes, etc.) has grown >50% organically in the past 5 years in EMs (which now makes up40% of its Foods business), but exposure to low-growth categories, such as spreads and mayonnaise, holds backits growth in DMs, whilst its HPC business (c.65% EM-based) has been impacted by a sharp slowdown in marketgrowth, due to declining consumer affordability and greater local competition.

Danone has historically beenhighly successful at premiumisation (e.g. Activia and Actimel in Europe, super-premium infant formula in China and Aquadrinks). But arguably the company was slower to react in terms ofadjusting its portfolio for a more frugal consumer in Europe, with price gaps of its Acti-brands versuscompetitors proving to be too wide during the recession, particularly as the brands can no longer be advertisedwith specific health claims under EFSA. However,Danone appears to bemaking significant steps towardsimproving its portfolio, working on making it more 'value added' at all price points.

Exhibit 51:Exhibit 51: The world will see strong population growth at lower and upper income levels, suggestingportfolios need to be geared towards polarisation (premiumisation + value/entry-level will be largest growthdrivers)

Sou rce: U N an d W orld B an k via Nestle, Morgan Stan ley Research

Exhibit 52:Exhibit 52: Danone's brand positioning coversbroad price points

Source: Company presentation

Exhibit 53:Exhibit 53: Nestle's multi-price-point/PPPstrategy

Source: Company presentation. Note: Coffee index based on priceper cup


37

EU Food companies are likely to apply their experience in EMs to drive premiumisation and brandsales through innovation, in our view: EU Food companies like Nestle and Unilever have years of experiencein understanding EM consumers and have been present in some countries, like India, for nearly a century. Thisprovides the companies with unique insight into how to straddle the portfolio and also innovate within thebrands to premiumise even the lower income consumer.

EU Food companies have ~50% of sales from EMs and ~20% from BRICs. Companies like Unilever have usedtheir experience in these countries to develop brands from more recent acquisitions. The success of TRESemmé,a relatively premium brand, has been a stand out example of brand development through increased distributionand brand building by Unilever, and this has helped improve Unilever's positioning within premium hair care. Itis pertinent to note that the growth since the brand's acquisition was largely fuelled by EMs, and morespecifically Brazil . We estimate that Brazil and India have contributed to over two-thirds of TRESemmé's growthsince the acquisition. TRESemmé Brazil has proven to be one of the most successful launches for Unilever,adding over €150mn in revenues in the first year since launch (representing ~15% of the entire retainedturnover from the Alberto Culver acquisition). In India, TRESemmé has been the fastest Unilever brand to Rs1bn(~€14mn) for Unilever India. The success of TRESemmé demonstrates Unilever's understanding of EMs where ithas been able to cater to all types of consumers by providing different SKUs (stock-keeping-units) and pricepoints.

Exhibit 54:Exhibit 54: Unilever: 'Maxing the Mix' (Premiumisation) strategy in Homecare, driven by consumerupgrading

Sou rce: U n ilever Presen tation , Morgan Stan ley Research

Exhibit 55:Exhibit 55: Emerging market exposure, 2015e

58%53%

44%Average: 52%

Dan

one

Uni

leve

r

Nes

tle

Source: Company Data, Morgan Stanley Research estimates

Exhibit 56:Exhibit 56: BRIC exposure

Danone Unilever Nestle

Brazil Russia India China

26%

20%16%

Source: Company Data, Morgan Stanley Research


38

Nestle has also used similar learning experiences to offer premium products at affordable price points andpremiumise the consumer. It has also been able to innovate and premiumise developed market / high incomeconsumers through the launch of Nespresso and Nescafe Dolce Gusto, which have each become >CHF 1bnbrands. An interesting case study is also on its KitKat brand in Japan. The premiumisation of KitKat in this markethas been of particular note, with the price of a limited edition KitKat (sold in a Nestle retail shop – ‘Kit KatChocolatory’ – at up to 5x the price of a mainstream KitKat).

Exhibit 57:Exhibit 57: TRESemmé - Different SKUs toCater to Different Consumer

Sou rce: U n ilever, Morgan Stan ley Research

Exhibit 58:Exhibit 58: Major Indian HPC companiesincluding Unilever and P&G premiumise thelower income consumers by offering smallerSKUs of premium brands

Sou rce: U n ilever, Morgan Stan ley Research

Exhibit 59:Exhibit 59: Nestle India - uses a strategy of offering premium brands at affordable price points

Sou rce: Nestle In d ia p resen tation


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US FoodUS Food


The companies most favorably positioned to navigate growing income inequality are those that cansuccessfully innovate their products to address changing consumer preferences towards better-for-youfoods, increased snacking, and a growing focus on value, in our view. We see MDLZ as well-positioned tobenefit from these trends, given that the company is innovating through new packaging formats toaddress growth at the low end, participates in the higher growth snacking category, and is increasingmarketing spend to support brand building and consumer awareness. In addition, WWAV should benefitfrom continued growth in the natural/organic segment

Most Favourably Positioned? WWAV, MDLZ

Within the US packaged food sector, the widening gap between high and low net worth individualshas manifested itself in several ways, with increasing consumer cost consciousness leading to tepidindustry growth, but also to isolated pockets of expansion among the premium natural/organic sub-segment. In particular, US large-cap packaged food industry sales have increased at only a 0.4% CAGR between2011-2015, with volume declining ~1.5% annually due to a reduction in store trips, lower pantry loading andconsumer waste, and an increased focus on buying necessities. This impact has been exacerbated by thereduction in the Supplemental Nutrition Assistance Program (SNAP) starting in late 2013 (affecting ~15% ofAmericans who receive Food Stamps) as the size of the program was reduced by ~$5 billion in fiscal 2014, andan additional $6 billion throughout 2015 and 2016, presenting an estimated ~40-70 bps annual headwind tofood expenditures. Additionally, traditional packaged food sales have been impacted by a shift in consumerpreferences towards healthy, better-for-you foods and fresh produce, benefiting growth in the perimeter of thestore, as well as natural/organic products. As a result, the premium-priced natural and organic food segmenthas grown by ~13% on average since 2010, significantly outpacing total food sales growth.

US Food manufacturers have tried multiple approaches to spur growth, given consumers' increasedcost consciousness. These have included heightened promotional activity in 2014, which did not result in theanticipated lift in sales, and more recently, a focus on providing better consumer value through optimizingpackaging sizes and price points. For example, the effort to better capitalize on the low end consumer isapparent in Mondelez International's (MDLZ) new packaging formats, such as smaller pack sizes at moreaffordable prices that improve accessibility to new households and channels. In addition, Pinnacle Foods (PF)recently introduced 'Perfect Size' packaging that caters to one- and two-person households, while CampbellSoup Co. (CPB) is expanding its presence in value channels through new products, package sizes, and price

Exhibit 60:Exhibit 60: US Large-Cap Food Sales have beenSoft

Source: Nielsen data, Morgan Stanley Research

Exhibit 61:Exhibit 61: Organic Food Sales have OutpacedTotal Food Sales

Source: Nielsen data, Morgan Stanley Research


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points.

Looking across our coverage, few companies stand out as being particularly exposed to the low andhigh ends of the income spectrum. The companies with the most exposure to the high income demographicinclude WhiteWave Foods (WWAV), given its focus on organic and better-for-you categories, and GMCR, as itsells premium priced single-serve coffee machines and K-Cups. Mead Johnson (MJN) appears to have thegreatest exposure to the low-end consumer, given that it sells infant formula, which tends to be more widelyused by lower-income households where mothers may have difficulty breast feeding because they need toreturn to work or where there is potentially less awareness about the health benefits of breastfeeding. From acategory perspective, there is little distinction in the consumption of the top 10 largest food categories acrossvarious income levels (we would note that our data captures whether someone has purchased a product in thelast six months, but does not capture the frequency of their purchases). The one category that appears to overindex to higher income individuals is snack and granola bars.

Companies are also expanding their offering of better-for-you, natural/organic foods to tap into thishigh growth segment. Given their substantial price premium, organic and better-for-you foods over-index tohigher income households, and growth in this demographic group should continue to benefit the category. Thisdynamic has benefited WWAV, whose products include plant-based beverages and yogurt, organic milk, andorganic packaged salad, and have enabled the company to grow organic sales at 10-11% annually. While

Exhibit 62:Exhibit 62: Natural/Organic Foods Skew Higher Income

Sou rce: MRI data , Morgan Stan ley Research

Exhibit 63:Exhibit 63: Generally Consistent Levels ofExposure to Income Groups, with the Exception ofWWAV, GMCR & MJN

Source: Nielsen, MRI, Morgan Stanley Research

Exhibit 64:Exhibit 64: The Top Ten Food Categories in theUS Have Relatively Similar Levels of ExposureAcross Income Levels

Source: Nielsen, MRI, Morgan Stanley Research


41

traditional packaged food companies have not historically participated in this category, they are becomingincreasingly focused on growing their exposure to this segment in order to accelerate topline growth throughproduct innovation/reformulation to simplify the number and enhance the quality of ingredients, as wellthrough M&A. This is apparent in General Mills' (GIS) recent launch of gluten-free Cheerios, a 25% reduction inYoplait sugar content, and acquisition of Annie's. Similarly, CPB acquired Bolthouse Farms in 2012 to expand itsoffering of fresh produce and premium beverages.

If inequality of income and wealth persists and widens further over the next 20 years, we wouldenvision the following longer-term implications for the US Food industry:

Which companies are most favourably positioned? We believe these would ultimately be companies thatcan successfully innovate their products to address changing consumer preferences towards better-for-youfoods, increased snacking, and a growing focus on value. We see MDLZ as well-positioned to benefit from thesetrends, given that the company is innovating through new packaging formats to address growth at the low end,participates in the higher growth snacking category, and is increasing marketing spend to support brandbuilding and consumer awareness. In addition, MDLZ's significant exposure outside of the US should betterinsulate it from evolving demographic trends in this market.

In addition, WWAV should benefit from continued growth in the natural/organic segment and offers adistinctive and compelling growth profile. WWAV offers a best-in-class organic growth outlook, driven by itsconcentrated portfolio of brands in high-growth food categories (plant-based beverages, coffee creamers,organic dairy), and recent topline growth has reached double-digits on sustained category trends, strength ofsuccessful innovation, and attractive acquisitions. In addition, WWAV has multiple levers that should facilitate50-75 bps of annual margin expansion including, (i) favorable segment mix dynamics; (ii) leveraging newmanufacturing, warehouse, and distribution capacity; and (iii) SG&A and gross margin efficiencies. As a result,we believe WWAV could generate ~20% EPS growth during 2015-17E.

Increasing demand for natural/organic products should, over time, make healthier foodsmore accessible to lower income demographics. Natural/organic food consumption ismore prevalent among higher income households because of their premium price points,which are driven by factors including: (i) higher production costs; (ii) elevated demand thathas exceeded supply; (iii) better living conditions for livestock; (iv) greater crop spoilage dueto the types of pesticides used; (v) the cost of obtaining organic certification; and (vi) highercosts across marketing/distribution due to relatively small volumes. However, as the largerfood companies increasingly participate in this category and modify their existing portfoliostowards healthier ingredients, these efforts should help democratize the cost of high qualityfood. In particular, their increased scale and efficiency in manufacturing as well as marketingshould not only reduce the cost of production/sourcing but also elevate awareness ofhealthier eating, thereby making such food more affordable and accessible.

Companies may increasingly focus on international expansion. Growing income disparityin the US could further encourage companies to expand internationally to potentially offsetdeclining middle class demand in the US. The companies in our coverage that are bestpositioned to benefit from growth outside of the US are MJN and MDLZ, which derive ~70%and 75% of their sales outside of the US, respectively. However, US Packaged Foodcompanies are making an increased effort to diversify outside of the US, with most of thecompanies in our coverage having exposure to international markets. In particular, Kelloggrecently announced its entry into a JV in Nigeria, while GIS is expanding Yoplait yogurt inChina and WWAV currently has a JV to commercialize plant-based beverages in China.


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US TobaccoUS Tobacco


We would expect the tobacco companies to be negatively impacted by widening income/wealthinequality as evidenced by the meaningfully lower smoking prevalence among higher incomeindividuals. Despite the relatively inelastic nature of cigarettes, over time, as low and middle classconsumers may have to allocate an increasing amount of their income to pay for costs such as childcare,healthcare spending, and retirement saving, their discretionary income available for cigarette purchaseswill likely decline, resulting in elevated cigarette volume declines as well as more limited ability for thetobacco manufacturers to raise prices.

The US tobacco industry is facing secular declines in cigarette volumes (~3-4% annually) due to a variety offactors including: (i) declining youth smoking prevalence; (ii) greater usage of alternative tobacco products suchas moist smokeless tobacco/e-cigarettes; (iii) lower daily smoking rates among non-Caucasian ethnicities; and(iv) indoor smoking bans. In addition, while cigarettes are relatively inelastic given their addictive nature, theyare impacted by economic conditions, such as unemployment rates, consumer confidence, the housing market,and gas prices. Despite declining volumes, the tobacco manufacturers have been able to maintain operatingprofit and high-single-digit EPS growth through higher pricing, which has averaged ~5% in the last severalyears, and cost cutting efforts.

In terms of income exposure, the tobacco companies skew towards lower income/net worth demographics assmoking rates are substantially higher at lower income levels. In particular ~24% of US smokers fall below thepoverty line, and socio-economic status has been found to be the single greatest predictor of tobacco use,serving as a way to relieve stress, cope with boredom given lower employment levels, and act as a companionto alcohol and caffeine usage(http://www.tobaccofreemaine.org/channels/special_populations/low_income_and_education.phphttp://www.tobaccofreemaine.org/channels/special_populations/low_income_and_education.php). Inaddition, given lower education levels, lower income individuals may be less aware of the health risks associatedwith smoking.

What happens if inequality of income and wealth persists and widens further over the next 20 years?We would expect the tobacco companies to be negatively impacted by widening income/wealth inequality asevidenced by the meaningfully lower smoking prevalence among higher income individuals. Despite therelatively inelastic nature of cigarettes, over time, as low and middle class consumers may have to allocate anincreasing amount of their income to pay for costs such as childcare, healthcare spending, and retirementsaving, their discretionary income available for cigarette purchases will likely decline. These dynamics may resultin elevated cigarette volume declines as well as more limited ability for the tobacco manufacturers to raise

Exhibit 65:Exhibit 65: Higher Smoking Prevalence AmongLower Income Levels

Source: MRI data, Morgan Stanley Research

Exhibit 66:Exhibit 66: 24% of People Below the Poverty LineSmoke

Source: CDC, US Census Bureau, Morgan Stanley Research


43

http://www.tobaccofreemaine.org/channels/special_populations/low_income_and_education.php

prices. While this may not be favorable for the industry, this would likely be beneficial to public health as it couldfoster lower smoking prevalence.

US and European BeveragesUS and European Beverages


Premium spirits/beer manufacturers are best positioned to capture the rising income inequality withtheir skew to higher-end consumers from a category perspective and skew to premium brands. Overall,we believe Constellation Brands, Diageo, Pernod and BrownForman are best positioned to capture thegrowth in premium spirits/beer.

Most Favourably Positioned: Constellation Brands (STZ), Diageo (DGE), Pernod (RI) and Brown-Forman (BFB)

Within beverages, rising income inequality in the US and the strengthening of the high end consumer shouldbenefit alcohol companies that are focused on the premium end, given the aspirational nature of brands in thecategory, as well as the on-premise (bar/restaurants) channel exposure to high-end consumer spending, whichis one-quarter of alcohol mix. Within our coverage, we believe Constellation Brands (STZ) would be the largestbeneficiary from this phenomenon, given its leverage to product categories (imported beer/wine) that skew tohigher-end consumers, and given STZ also has a premium brand portfolio. Diageo (DEO), Pernod (RI), andBrown-Forman (BFB), should also benefit, with their portfolios skewed towards premium spirits.

Among the non-alcohol beverage companies we cover, we believe that income inequality has been much less ofa factor given the less aspirational nature of major categories. However, we do believe an indirect benefithelping to offset the negative impact of weaker low-end consumer spending has been the recent favorable shiftamong beverage companies (particularly Coke, and to a lesser extent Pepsi and Dr. Pepper) to focus on smaller,lower price per unit packages (albeit higher price per oz), which has driven category profitability and a morerational US pricing environment with limited demand elasticity.

Income Inequality: According to MRI data, we see a clear distinction between the alcohol and non-alcoholcompanies we cover in regard to category participation (ie. % of individuals who have used a product within acategory within the last 6 months) by household income level. As illustrated below, using a category salesweighted average for each company, STZ most heavily over-indexes towards the high end consumer, followedby DEO, RI and BFB. On the other hand, PepsiCo (PEP), Dr. Pepper (DPS), Monster (MNST) and Coke (KO)category participation rates are much less differentiated across income groups, while under-indexing slightly at

Exhibit 67:Exhibit 67: Category Participation Is RelativelyConsistent Across Non-Alcohol Companies

Source: GFK MRI, Morgan Stanley Research

Exhibit 68:Exhibit 68: Alcoholic Beverages Companies'Category Weighted Average Participation Over-indexes Towards High End Consumers

Source: GFK MRI, Morgan Stanley Research


44

the very high end. Given much greater sensitivity to income demographics, under the context of the debate onincome inequality, we would focus a greater amount of attention on the alcoholic beverages space.

Alcohol Industry: A rebound in the high-end US consumer has benefitted alcoholic beverage companies ingeneral with the more aspirational nature of the category and reliance on bar/restaurant traffic, and particularlythose companies with premium priced brands. Within beer, elevated income inequality with a continued anddisproportionate strengthening of the high-end consumer favors premium priced imported and craft beers,while a tepid recovery among the low end consumer would continue to weigh on mainstream domestic beerbrands. Broadly, wine and spirits typically skew towards the higher end consumer and have been gainingcategory share from beer, with increasing demand for higher quality/more aspirational brands supportinghigher growth on the premium end.

We Flag STZ as the Best Way to Play the Secular Income Inequality Theme: Within our coverage, webelieve that Constellation Brands is most favorably positioned to benefit from rising income inequality, given itsportfolio of premium Mexican imported beer, and wine and spirits business. Not only do STZ's productcategories skew to high-income consumers, but the premium nature of its beer portfolio also drives greaterconsumption by high-end consumers, with STZ's beer portfolio (worth 60% of STZ profit) at an average +36%retail price per case premium vs. the industry average YTD. The price premium is an even greater ~50% relativeto its major beer competitors Anheuser-Busch InBev and MillerCoors, which collectively represent ~75% of theUS beer market by volume.

As illustrated in Exhibit Exhibit 7070 , partially aided by a recent consumer spending recovery of high-end consumers,Constellation's tracked channel beer retail sales growth has accelerated on an absolute basis, as well as relativeto major beer peers, with +1,570 bps of outperformance YTD vs. the average growth rates of Anheuser-Buschand MillerCoors, up from +1,470 bps in 2014, +1,060 bps in 2013, and +610 bps in 2013. While a number ofother factors are driving this expansion, including improved marketing and execution, demographic tailwindsfrom Hispanic consumers, and more recently the launch of Corona cans, we believe that improving consumerspending has played a meaningful role in Constellation's acceleration relative to lower priced mainstreamcompetitors.

Within Spirits, Diageo is a good way to play the Secular Income Inequality Theme, as well as Pernod:We believe that Diageo is well positioned to benefit from rising income inequality given its premium portfolio,both in the US and in other developed markets. In the US, Diageo is the market leader in volume terms, with19% share in 2015 YTD according to Nielsen data. The average price per unit for Diageo is +17% premium tothe US spirits market, and Diageo's value share of the spirits market is 22%.

Exhibit 69:Exhibit 69: STZ Beer Sells at a ~50% Premium toMajor Beer Competitors

Source: Nielsen, Morgan Stanley Research

Exhibit 70:Exhibit 70: STZ Beer Sales Growth Acceleratingon an Absolute and Relative Basis

Source: Nielsen, Morgan Stanley Research


45

In the US and elsewhere, Diageo's reserve brands should also benefit from an increased concentrationof wealth. Since 2005, premiumisation has accelerated and Diageo's reserve brands portfolio have postedrobust growth. The growth of wealthy consumers is a fundamental driver for the growth of the premium spiritsmarket. To the extent that increasing income/wealth inequality is enhancing the spending power of wealthyconsumers, it should help drive demand for high end spirits, such as Diageo's reserve portfolio.

US Household Products & Personal CareUS Household Products & Personal Care


Within household products, income inequality is unlikely to have a major demand impact given theproducts tend to be more essential staples items and demand less sensitive to consumer income.However, we would point to companies positioned in categories where brand equity is more importantand where we see trade-up potential as better positioned to benefit from rising income inequality. Webelieve Estee Lauder is poised to benefit the most from rising income inequality.

Most Favourably Positioned: Estee Lauder (EL), Blue Buffalo (BUFF)

Within household products, income inequality is unlikely to have a major demand impact given the productstend to be more essential staples items and demand less sensitive to consumer income. However, we wouldpoint to companies positioned in categories where brand equity is more important and where we see trade-uppotential as better positioned to benefit from rising income inequality.

Exhibit 71:Exhibit 71: Volume and value market share

Source: Nielsen xAOC ex Washington, Morgan Stanley Research

Exhibit 72:Exhibit 72: Average price per unit

Source: Nielsen xAOC ex Washington, Morgan Stanley Research

Exhibit 73:Exhibit 73: Reserve Brands volume since 2004

Source: IWSR (2014), Morgan Stanley Research. Note: the agreementwith Ketel One started in 2008

Exhibit 74:Exhibit 74: Reserve Brands volume growth rate

Source: IWSR (2014), Morgan Stanley Research


46

We prefer companies with greater exposure to beauty and personal care categories, which have higher pricingpower, vs. typical household products categories that have greater trade-down risk and higher private labelpenetration, and less product differentiation within specific sub-categories. We conducted an AlphaWiseconsumer survey of 2,000 US consumers in May of 2013 to gauge which staples companies have the mostpricing power, based on nine key questions related to consumer trade-down. Within the HPC space, we saw aclear distinction in pricing power between household products categories (e.g. bleach, soap, cleaners, etc.), andpersonal care categories (e.g. beauty, oral care, skin care, etc.), which have greater pricing power, as illustrated inour survey results below.

Based on category exposure alone (ie agnostic of brand equity), Beiersdorf, Unilever, L'Oreal, and EL are themost favorably positioned from a pricing power perspective, while Clorox, Henkel, and PG are the leastfavorably positioned, in our view.

Within personal care, beauty products tend to have the greatest pricing power, with brand equity a criticalcomponent behind purchasing decisions. Additionally, the highly aspirational nature of beauty care products hasenabled high-end brands to command significant price premiums relative to the category in general. Within ourcoverage, Estee Lauder (EL) stands out as the most favorably positioned from the perspective of a continuedstrengthening in the high-end consumer, given its positioning as a pure-play prestige beauty company.According to MRI data on consumer use of key brands by company, EL significantly over-indexes to high-endconsumers, whereas brand use is less differentiated by income levels among other HPC companies, asillustrated in Exhibit Exhibit 7777 .

We also point out Blue Buffalo as positioned to benefitfrom growth in the higher income segment (BUFF).BUFF is the leading brand of wholesome natural petfood (Blue Buffalo defines wholesome natural as brandsthat achieve their nutritional goals by using onlynatural ingredients, and does not contain chicken orpoultry by-product meals, grain proteins, corn, wheat,soy, or fractionated grains), a premium sub-categorywithin the overall pet food market that typically sells atpremium price points and is now at 9% total pet foodunit share. As illustrated in Exhibit Exhibit 7878 , the wholesomenatural pet food sub-category has gained a large +600bps of $ market share of the total pet food industryfrom 2011-2014 to 17%, largely at the expense of lowerpriced, value engineered and private label players. Asignificant driver of this shift has been the humanisationof pets trend, where pet parents have become much more critical of what their pets are consuming, leading toan increased willingness to pay premium prices for enhanced well-being. Within the faster growing wholesomenatural segment, Blue Buffalo has been the clear winner, with industry leading market share gains over the lastseveral years despite a premium price point. To illustrate BUFF's distinctive momentum and positioning vs. the

Exhibit 75:Exhibit 75: Personal Care Categories Had MorePricing Power than Household ProductsCategories...

Source: AlphaWise, Morgan Stanley Research

Exhibit 76:Exhibit 76: ...Companies with Greater Exposure toPersonal Care Categories Had Greater PricingPower

Source: AlphaWise, Morgan Stanley Research

Exhibit 77:Exhibit 77: Within HPC, EL Over-Indexes to theHigh-End Consumer to a Greater Extent thanPeers

Sou rce: G FK MRI Data , Morgan Stan ley Research


47

broader pet food industry (including engineered brands and vet brands), in Exhibit Exhibit 7979 we mapped three-yearmarket share change (2011-14) by brand vs. average price points. Blue stands out within the group, with marketshare gains far outpacing its key competitors, while also maintaining a higher-end price point.

With a continued strengthening of the high end consumer, we would expect for premium priced and higherquality wholesome natural pet food brands to continue gaining market share at the expense of lower priced,value brands. We believe that BUFF would be a clear beneficiary here given its 100% exposure to thewholesome natural segment, leading market share position within wholesome natural, and strong brand equity.

European Household Products & Personal CareEuropean Household Products & Personal Care

Bottom Line

In European HPC, inequality is likely to drive polarisation of growth drivers across categories, withmarket growth driven by premium (eg products including Health & Wellness benefits) and the value endof the market, with the mass market capturing less of the market growth. All the companies in theEuropean sector have product ranges in place to address this. We however believe that Reckitt andL'Oreal appear particularly well positioned, as both have successful track records in driving growth at theends of their markets: L'Oreal through its well established strategy to cascade innovations over pricepoints, and RB to leverage uptrading in Consumer Health while covering a wide range of price points inHygiene and Home

With growth across both the Home and Personal Care categories increasingly driven by the top andbottom end of the markets, the companies' relative success in adapting to this will be a key driver ofrelative growth rates, in both developed and emerging markets. Companies across categories in the HPCspace have broadened product ranges, to cover both the top and lower parts of the price ranges withinindividual categories to cater to both the while products in mid-market positions capture less of the growth.Overall we think that this differentiation strategy has potential to be more effective in Personal care than inHousehold care - with many Household care categories tending to be more essential staples items and demandless sensitive to consumer incomes. Past surveys we have conducted on the other hand found that Personal careand particularly Beauty categories had higher pricing power based on brand loyalty and lower risk of tradedown, as outlined in Exhibit 79 below.

Exhibit 78:Exhibit 78: Premium Priced Wholesome NaturalDog Food Has Gained Significant Market Share atthe Expense of Value Segments...

Source: Company data, Morgan Stanley Research

Exhibit 79:Exhibit 79: ...With Blue Buffalo the MostSignificant Driver of Wholesome Natural CategoryShare Gains

Source: Company data, Morgan Stanley Research


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Within this context we think that Reckitt Benckiser and L'Oreal are well positioned for the bifurcation in themarket resulting from rising inequality, with both companies having ranges covering price points: L'Oreal withinthe personal care space covers the top end in its Luxe division and mid to lower end in Consumer Products.Reckitt's Consumer has products to capture trade up, particularly in Consumer Health, while the group's Homeand Hygiene include a range of price points.

Beiersdorf has positioned the Nivea brand at'democratic' price points, targeting to access consumersacross mass market but also budget channels - butleveraging the strength of the Nivea brand. Thecompany's innovations since 2013 have been aimed atsystematically covering targeted price points within itssix core categories, from the upper end with NiveaCellular and Nivea Q10 Pearls Serum, to the Nivea Carecream launched earlier this year. A key part of this effortis the focus on regionalisation since 2014, with thecompany investing in production and productdevelopment infrastructure in many markets (eg Indiaand Latin America) to better target local tastes,

L'Oreal remains highly focused on differentiatedinnovation, leveraging its leading R&D organisation tolead the market in product performance and this hadtraditionally left it positioned at the top end on pricingin many of its categories. And while across markets L'Oreal aims for its brands to be aspirational , as part of itsstrategy to target 1 bn new consumers, the company has worked more with differentiation across both points ofthe price spectrum. This applies both to developed and emerging markets with L'Oreal aiming at incrementalconsumers also in Western Europe and the US. The group's brands are positioned to complement each otheracross the price pyramid and through cascading innovations are leveraged across brands.

Reckitt Benckiser is leveraging premiumisation opportunity in Consumer Health, adapting the Householdportfolio. A key driver of the group's aim to shift the portfolio towards Consumer Health is the demographictailwinds in these categories combined with high brand loyalty which underpins pricing power behind thesebrands, which for example has resulted in low (and not expanding) private label share in many Consumer Healthcategories. Within the Hygiene and Home divisions, RB has also developed more differentiation within theproduct range, both to enable it drive growth in EMs but also to target lower price points in developed markets,with smaller pack sizes or products such as the Vanish Laundry bar, albeit while maintaining a strong emphasis

Exhibit 80:Exhibit 80: Personal Care Categories Had More Pricing Power than Household Products Categories...

Sou rce: Alph aW ise, Morgan Stan ley Research

Exhibit 81:Exhibit 81: Price ranges by various HPCcategories

Sou rce: Compan y Data , Amazon .com, Seph ora .fr,boo ts.com, Morgan

Stan ley Research

Note - Prices fo r sk in care b ran ds are per 20ml an d th ose fo r

too th paste are per 75ml. Prices fo r detergen ts are fo r similar SKU

produ cts


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on product performance.

Henkel differentiating within mass market positions. Within its HPC business Henkel's key brands arepositioned in the mass market segment but with a range of brands to cover both the upper (eg Persil andSchwarzkopf Gliss Kur) and lower (Weise Riese in detergents and Schwarzkopf Scauma in hair care) ends of theprice spectrum. An interesting example of this is the launch of Persil detergents in the US early this year, whichwas launched in an exclusive co-operation with Wal-Mart (being extended to other retailers now) but at amarked price premium to its established Purex brand in the US. In haircare the launch of Schwarzkopf EssenceUltime is also being rolled out at a premium to established parts of the Schwarzkopf range.

SCA targets a range of price points with branded and private label products. SCA's products in theHygiene space (baby diapers, incontinence products, femcare and tissue) are some of the least discretionary inthe HPC space in our view. While the company has put more emphasis on innovation in the last years, with alarge number of products launched in 2015, we think that a key attraction for the group is its ability to cater toall ends of the price spectrum. In Tissue, about half of sales are private label with SCA one of the leadingEuropean suppliers here. At the other end of the range for example the Libero brand is at a premium positioningin its key markets (Nordics, Eastern Europe and more recently launched in China) - SCA has here gone through asignificant investment project to upgrade its production technology to improve product quality (eg Libero Touchlaunched recently).

Exhibit 82:Exhibit 82: Nurofen tablets price range

Source: Boots.com, Morgan Stanley Research

Exhibit 83:Exhibit 83: Detergent Price range

Source: Walmart.com, Morgan Stanley Research


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Healthcare: A Tale of Multi-Regionalism - The Rise of the HealthcareHealthcare: A Tale of Multi-Regionalism - The Rise of the HealthcareConsumer in the US and Push for Innovation in the EUConsumer in the US and Push for Innovation in the EU

Michael K Jungling, +44 20 7425-5975Vincent Meunier, +44 20 7425-8273David Risinger, +1 212 761-6494Matthew Harrison, +1 212 761-8055Ricky Goldwasser, +1 212 761-4097David R. Lewis, +1 415 576-2324Andrew Schenker, +1 212 761-6857


Healthcare trends vary widely across global regions and as such we took a regional approach todiscussing the impact of increasing inequalities. In the US, represented by the views of our NorthAmerican team (Goldwasser/Harrison/Lewis/Schenker/Risinger), healthcare is steadily evolving towardsa consumer driven market as high deductible plans give more cost responsibility to consumers and datatransparency tools are on the rise. In Europe, represented by Morgan Stanley EU pharma and medtechteams ( Meunier/Jungling) market segments continue to diverge as innovation and access to affordablehealthcare are increasingly important, and increasing inequalities could further drive growth in cheapgenerics and consumer healthcare (out-of pocket spending).

Europe and Emerging Market HealthcareEurope and Emerging Market Healthcare

Many developed countries (ex-US) provide government-backed medicine to offer equal healthcare for theirpopulations. An example of European socialized healthcare management is the UK's National Institute forClinical Excellence (NICE), which states on its website, "Since 1999, we have provided the NHS [National HealthService], and those who rely on it for their care, with an increasing range of advice on effective, good valuehealthcare, and have gained a reputation for rigor, independence and objectivity." NICE and other costmanagement bodies manage spending to offset aging populations by applying stringent spending controls.

As shown on the chart below, countries with higherGDP tend to spend more on health. The associationappears stronger in countries with low GDP per capitathan among OECD countries with a higher GDP percapita.

We believe a first consequence of increasinginequalities would be an increase in overall drugspending, as a significant portion of the expectedgrowth is driven by the ongoing surge of the middleclass in emerging markets, and rising wealth isassociated with greater spending on healthcare.

Economic analysis conducted by the EU parliamentshows that richer EU member states appear to spendmore on pharmaceuticals, as a result of higher averagedrug prices and higher per capita consumption in volume terms (or a combination of both). Assuming drug

Exhibit 84:Exhibit 84: Per capita GDP is driving healthspending

Sou rce: O ECD 2011


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prices and patient access will continue to be set and controlled by states, an increase of inequalities wouldlead (in Europe) to more pricing pressure and increased penetration of generics drugs.

As shown in the chart below, out-of pocket spending is higher in countries with lower GDP per capita. As aresult, we estimate that increasing inequalities could further drive growth in consumer healthcare (out-of pocket spending), not only in countries with low GDP but also in developed countries, where consumerscould demand the most cost effective drugs.

What happens if inequality of income and wealth persists and widens further over the next 20 years?

Are there any potential beneficiaries from this? One conclusion is to back companies with a high exposureeither to innovative pharmaceuticals (with medical differentiation), Consumer Healthcare (low developmentcosts, strong brands, price premium) addressing the wealthy segments, or with generics allowing them todeliver a sustainable business model for the squeezed middle.

In Europe, we think companies with the best exposure are Roche (expected to remain a world leadinginnovation-driven company in oncology), Novartis (expected to remain a world leading innovation-drivencompany in oncology and in generics) or Novo Nordisk (expected to remain a world leading innovation-drivencompany in diabetes). Other players appear well placed at first take, due to high exposure to emerging markets(Sanofi expected to remain world leader) and/or Consumer healthcare (GSK expected to remain world leader);however, they still have to address the challenge on the rest of their portfolios (erosion in diabetes for Sanofi,erosion in respiratory for GSK) and deliver on innovation. Other companies are still transitioning and have

Exhibit 85:Exhibit 85: Out of pocket drug spending is higher in countries with lower GDP per capita

Sou rce: W orld Health O rgan ization 2011, W orld B an k 2011

Innovation would continue to be crucial to address unmet medical needs with strongenough clinical differentiation. Innovation would be more than ever key for sustainingpricing power and address the premium segment.

Penetration of generics would further increase, including biosimilars. The increasingdemand for affordable medicines would put economic and political pressure on both privateand public payors to ease and increase the use of cheaper copies. Generics of biotechproducts (biosimilars) would then be a key driver.

Companies would have to clarify their choice of business model. Both the top and bottomof the pyramid could be successfully addressed by a single company, but companies maywant to concentrate on leadership in part of the value chain. Companies at the top of thepyramid with undifferentiated products (on medical value or cost) would be exposed to salesand margin squeeze.


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recently materially increased their investments in R&D (AstraZeneca) and/or Consumer Healthcare (Bayer).

Within medical devices the inequality gap is best examined between major geographic regions, due todifferent types of healthcare reimbursement systems. And the different healthcare systems can turn an essentialmedical service involving a medical device into a luxury product. Before going into the various healthcaresystem models, we thought it would be appropriate to provide a short overview of what medical devices are.Medical devices are products, which help to overcome a medical condition, that can typically not be solved bypharmaceuticals. Some of the main areas include:

Essentially we believe there are four basic healthcare system models when looking at medical deviceprocedures. The Beveridge Model, was named after the social reformer William Beveridge who designedBritain's well known National Health Service, where funding is provided directly by the tax payer. Essentially,under this model access to healthcare is free and the patient rarely sees a material bill for the medical procedureperformed. Countries which have adopted this model include Great Britain, Spain, most of Scandinavia, NewZealand and Hong Kong. The Bismarck Model, is also a socialistic based system and named after PrussianChancellor Otto von Bismark, who created the welfare state during the unification of Germany in the 19thcentury. The model is based on an insurance system, whereby employees join an insurance company, which isnot allowed to make a profit. The coverage is funded by both the contribution of the employer and theemployee and the insurance companies have to accept everyone. Adopters of this model include Germany,France, Belgium, Holland, Japan, Switzerland and some south American countries. There is the National HealthInsurance Model, which is more of a hybrid between the Beveridge and Bismarck systems and is found inCanada, Taiwan and South Korea. The fourth model is the Out-of-Pocket Model, whereby the patient has tofully fund the medical procedure themselves; this is mostly the cases in poorer countries where insufficient GDPdoes not allow to provide medical care for the masses and includes most of Africa, India, some South Americancountries; China used to be in this category, but due to strong increases in GDP, many Chinese now have basicaccess to government healthcare. Under this model, the inequality of medical care is the greatest, with the richerpeople readily getting access, while the poorer segment goes without medical attention, which can clearly leadto prolonged illness and death.

Is I t Affecting Medical Device Companies? The widening gap between high and low net worth individualshas been affecting some medical companies more than others. In developed countries, companies have investedsignificantly in R&D to drive improved products, for which payers are willing to pay, while in poorer countriesthey only get access to significantly older technology. Some medical devices companies have invested in newand fast growing areas, such as aesthetics to accommodate the growing appetite to look forever young; thisincludes dental implants (effectively artificial dental roots) for a patient who wants a perfect aesthetic smile,breast implants, and skin stretching for wrinkle improvement; the wealthy with high disposable incomes havenot hesitated to take advantage of the technology. Other companies such as Smith & Nephew launched theorthopedic industry's no frills hip and knee implant system in 2015 called Syncera, which is the first attempt tounbundle service from product, to be able to provide a more cost effective solution in the developed markets,akin to what we have seen in the airlines industry with Ryanair and easyJet.

Although emerging markets continue to lag the GDP per capital of the developed markets, their growing wealth

Orthopedics: this is a large segment within medical devices which addresses osteoarthritisand requires hip and knee joint replacements, mending broken bones or reducing back paindue to degenerative disc disease.

Cardiovascular: unblocking occluded vessels, addressing irregular heart beat (pacemaker ordefibrillator) or replacing heart valves.

Imaging Diagnostics: helping diagnose disease with images from X-ray, MRI or PETmachine.

In-vitro Diagnostics:performing tests on human tissue, blood or urine samples to help withdisease diagnosis.

Dentistry: addressing cavities, teeth straightening and replacing missing teeth.

Dialysis: providing blood pumps and filters to clean the blood due to kidney failure


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has nevertheless driven the medical device manufacturers to come up with new strategies and product solutionsto benefit from the growing healthcare demand. Thestrategies vary from the re-introduction of old products(all the R&D has been earned back making theseproducts cheap to produce) which are no longerrelevant in the Western world, but offer a great benefitto the citizens of other affluent countries. Companieslike Varian and Elekta have developed dedicated lowcost linear accelerators in radiation therapy, produced inChina, to end up with sub $1mn solutions compared tothe standard price of a more sophisticated product inthe western world of $2-2.5mn.

Price Segments: we would argue that the growinginequality in patient income is likely to continue to drivea more diversified product approach of low to high-endproduct solutions. The degree of product segmentationwill depend on whether the medical device isreimbursed by governments, health insurers or whetherthe device/procedure is self pay. In most developed markets such as Germany, Japan and the United States, wedo not see any dramatic changes, although government /insurance company focus to contain healthcare costs islikely to cause companies to focus R&D on medical devices that can reduce overall healthcare costs. In countriesor in end-markets where there is a high degree of self-pay, such as many emerging markets, we believe medicaldevice companies will need to broaden their product offerings to products which are simpler and cheaper toproduce, that make them more affordable for self payers or emerging government healthcare systems. As aresult, we see it as likely that the product portfolio of medical device companies will expand from high-end toincreasingly mid and low-end products.

A good example has been the hearing aid industry,which in the late 1990s and early 2000's was focusedon high-end products. However with the averagehearing aid price readily increasing from $1,300 perunit in the United States to $2,500 in 2014/15, theproduct has become increasingly a product solution forthe higher income earners (especially since mosthearing impaired people need to buy two for a totalcost of ~$5,000). As a result, we have seen emergenceof potentially disruptive business models / technology,which are trying lower the price, including personalsound amplification devices (PSAPs) which is more of aconsumer electronics solution to hearing loss vs. thetraditional device of a hearing aid. Assuming inequalityof income and wealth persists and widens further overthe longer term (next 10-20 years), there may bepotential for a further push for cost savings in deviceswhether from genericized versions or a costsegmentation marketing model. The recent CardinalHealth acquisition of Johnson & Johnson’s Cordis unit points to potential for genericized devices to make amore meaningful present in the market.

Potential Benefits & Challenges: given that in many developed markets, the government providesreimbursement, we do not expect on average many beneficiaries within the sector from widening inequalitiesover the next 20 years. Most medical device companies have been combining R&D with healthcare economicsto help reduce overall healthcare costs through product innovation. For medical devices which are notreimbursed or only have a little bit of reimbursement, such as cosmetics, hearing aids, dentistry and eye glasses,the situation may be a little bit more complex. But effectively we believe companies have the ability to adapt

Exhibit 86:Exhibit 86: Smith & Nephew: Syncera lower costsolution for hips and knees

Sou rce: Smith & Neph ew , Morgan Stan ley

Exhibit 87:Exhibit 87: Elekta: Compaq entry level linac forChina

Sou rce: E lek ta , Morgan Stan ley


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over time and expand their product portfolio to cater for the demand from the wealthy (high-end solutions), allthe way down to the lower income earners (value

based solutions). One area of medical devices that couldbe a clear winner is the cosmetic medical deviceindustry, where the desire to look younger, provides anincentive to spend surplus disposable income on areassuch as better looking teeth, smoother looking skin, hairtransplants, or breast implants. Another area that couldbe a winner are private hospital operators, whereby thewealthy take advantage of getting around waiting lists,that are typically associated with governmentreimbursed systems. Provided in the exhibit below is anoverview of the number of financial trusts (which runNHS hospitals) in breach of their waiting time targets,showing the increasing waiting lists and challenges tothe service.

A potential loser, is the hearing aid industry withparticipants such as Sonova and William Demant, where the business model and margin structure are highlyvulnerable to changes in government regulations, which could provide easier entry to the consumer electronicsindustry to supply low cost hearing aids, with a much lower profit margin.

Greatest Risk From Widening Equalities: while a large proportion of healthcare is paid for by governments inthe developed world, there has been an increasing trend for patients to make a co-payment for their medicalprocedure; this is a function of healthcare systems trying to deal with rising healthcare costs. This has beenespecially the case in the United States, when it comes to commercially insured patients, but we are also seeingthis in other geographies. Over time we see a risk that rising inequality will make it more challenging for lowerincome earners to afford rising co-pays, which will slow the demand for medical devices.

US HealthcareUS Healthcare

In the United States, we have seen a trend toward increased patient responsibility and cost sharing - atrend we believe will continue going forward. For example, a Kaiser Family Foundation study determinedthat while premiums increased 61% from 2005 to 2015, the patient contribution portion increased 83% over thesame period. While the Affordable Care Act expanded insurance coverage to every American, it has not yetsolved the issue of access. As highlighted in the exhibit below, lower income patients are more likely to choose aBronze or Silver plan due to a lower monthly premium. This puts pressure on utilization of the overall healthcaresystem as higher deductibles require mostly out of pocket payments when patients need care, which lowerincome families may be unable to pay. Over time, we believe this could benefit more affordable venues of care,such as the CVS Minute Clinic.

Generic industry leader Teva is well positioned to address the inequality gap by capitalizing on growing

Exhibit 88:Exhibit 88: Trusts are increasingly breachingwaiting times for acute therapies

Sou rce: Mon ito r, Morgan Stan ley

Exhibit 89:Exhibit 89: Comparison of Healthcare Exchange Expenses Across Plans and 2 States

Sou rce: Health care.gov


55

demand for low-cost generic pharmaceuticals. Highly innovative pharmaceutical companies can also bewinners, as long as governments do not aggressively squeeze pricing. US innovators AbbVie, Bristol Myers,Eli Lilly, and Merck are developing transformational new medications for hepatitis-C, oncology, diabetes, andcentral nervous system disorders. Although most innovative pipeline products will be high cost, they can help tolower overall healthcare industry costs and extend patient lives. A company which is exposed to potentialpressure from inequality is Valeant, since the company has employed a business strategy to maximize USpricing to the greatest extent possible and it invests little in innovation to lower future health system costs.Similar to US Innovative Pharmaceuticals, US Biotechnology provides a similar value proposition. Keyinnovators including Alexion, Amgen, Biogen, Celgene, Gilead, Regeneron and Vertex are also developingkey new treatments for Hepatitis C, Hepatitis B, oncology, Cystic Fibrosis, osteoporosis and cardiovasculardisease. While these treatments will also have high costs, if used appropriately, they can lower overall healthcarecosts and extend patient lives. Within the US specialty pharmacy channel, the only public, independent USspecialty pharmacy is Diplomat, which offers exposure to innovative medicines requiring a high touchdistribution model. CVS/WBA may also benefit from increasing inequality, as their stand-alone walk-in clinicsprovide access to patients searching for affordable primary care.

Managed Care - One of the key provisions of the Affordable Care Act was to expand Medicaid, the jointly stateand federal financed program to provide healthcare to low-income individuals. Specifically, the ACA increasedMedicaid coverage to individuals that had annual incomes up to 138% of the Federal Poverty Level (FPL) ormade ~$16,000 a year in 2015. While a 2012 US Supreme Court ruling gave states a choice about whether theywould expand Medicaid, the majority of states (57% or 29 states + DC) decided to expand their programs. As ofMarch 2015, ~7M additional individuals in the United States had Medicaid coverage due to the coverageexpansions. We believe Medicaid enrollment will continue to grow given 1) the high degree of churn among thispopulation and 2) the possibility more states could expand Medicaid. As such, we think the inequality gap hasbenefited managed care companies that specifically serve Medicaid populations. Two companies we wouldhighlight are Centene (CNC) and Molina (MOH), which almost exclusively provide health benefits to Medicaidbeneficiaries. Notably, CNC had annual returns of 76% in 2014 and Molina returns of 54% last year.Additionally, the stocks are up 20% on average YTD.

As mentioned in the above sections, the inequality gap is driving an increase in consumerism, which isparticularly evident in the health insurance marketplace. We believe companies best positioned for thismovement would be those with the most robust consumer offerings. In this environment, we would highlightAetna (AET) and UnitedHealth (UNH) for their consumer-oriented products. For example, UnitedHealth's Optumbusiness has a number of key tools including its Health Advantage mobile app for HSAs and Rally, its digitalconsumer engagement platform. Similarly, Aetna's Healthagen division advances its provider collaboration andconsumer empowerment strategy.

Within Medical Devices, the overall impact of inequality has been relatively insignificant. Despite wideninginequality, the advent of the ACA has coincided with an increase in procedure volumes and utilization in the US.European device end markets are largely dominated by national healthcare systems that also will likely seelimited impact from inequality gaps. Assuming inequality of income and wealth persists and widens further overthe longer term (next 10-20 years), there may be potential for a further push for cost savings in devices whetherfrom genericized versions or a cost segmentation marketing model. The recent Cardinal Health acquisition ofJohnson & Johnson’s Cordis unit points to potential for genericized devices to make a more meaningfulpresence in the market but we are cautious, absent more evidence supporting such a trend. In a similar vein,Smith & Nephew launched Syncera, a new discounted, hospital focused sales model, where the company isoffering its Genesis II Knee and combination Synergy hip stem and reflection cap with discounts of around onethird of the price in exchange for a lower touch and more basic technical support. While still early, we believethat uptake has been fairly limited, and the full potential of a cost conscious segmentation of the market remainsto be seen. Overall, we see the inequality gap as likely having more second to third order effects on the medicaldevice industry with any impact likely many years away from making a meaningful or quantifiable impact withinvarious end markets and company business models.


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Luxury: Providing entry for the 'aspirational' consumerLuxury: Providing entry for the 'aspirational' consumer

Louise Singlehurst, +44 20 7425-7239Elena Mariani , +44 20 7425-0527Josephine Tay, +44 20 7425-3623


Luxury brands sell goods to a small minority of the world's population. We do not see a risk specificallyto the luxury brands from widening inequality trends - providing the high-net worth population growsalong with the rising pool of aspirational consumers from Asia, these companies are well positioned tobenefit. We expect brands will continue to take advantage of growth at the entry level ('aspirational')category given the appetite for luxury from the Chinese spending globally. Overall, we think Richemontand LVMH are best positioned.

Luxury and Inequality: The luxury brands by their very nature sell goods to a small minority of the world'spopulation. Growing consumer wealth along with the rise of the 'aspirational' consumer have been clearpositives:

Pricing: On our estimates, over the 10-year period 2004-14 pricing accounted for ~25% ofannual growth across the luxury peers. The brands benefited from rising volumes along withstrong pricing power. These goods - watches, jewellery, leather goods and accessories - arecharacterised by high barriers to entry and the brands are best-in-class marketers - creatinga sense of scarcity value. We think the leather/accessories and apparel brands have benefitedmost.

Exhibit 90:Exhibit 90: As a proportion of growth, pricingreached new highs in 2014, we estimate

Source: Morgan Stanley Research estimates. Note: 2009 is averageof 2008 and 2010 (2009 itself is not meaningful given volumecontraction).

Exhibit 91:Exhibit 91: Leather/Accessories segment hasbenefited most from pricing, in our view

Source: Morgan Stanley Research estimates

Premiumisation: In addition to pricing power, the luxury brands have introduced moregoods at the high end - fuelled by rising wealth and consumers willingness to use luxurygoods as a display of net worth and/or success. The latter point is particularly important forAsian consumers.

Introduction of more entry price points for the 'aspirational' consumer: This is not for the


57

'low net worth' individual, but the aspirational consumer who is willing to prioritise spendingon high end brands. The purchase of a handbag from Louis Vuitton may be out of thequestion, but a scarf or pair of sunglasses may be affordable. Many brands have movedbeyond their core offering and widened the product base to attract a broader demographic.As growth has slowed in Western Europe, this has been important to volumes.

Exhibit 92:Exhibit 92: On average, leather/accessoriesrepresent ~30% of luxury sales


Exhibit 93:Exhibit 93: Peer group split by product segment -many brands have moved beyond core offering

Source: Company Data; Morgan Stanley Research

Growth by nationality continues to evolve: Twenty years ago, the largest consumer groupof luxury goods were the Western European high net worth individuals. Whilst the luxurycompanies do not disclose revenues by nationality (only by geography) we estimate WesternEuropeans now account for nearer 20% of sales for the global brands (down from 40% 10years ago), this is adjusted for tourism related sales.

Exhibit 94:Exhibit 94: Peer groups have on averagesignificant exposure to the Chinese nationalglobally

Source: Company Data; Morgan Stanley Research estimates

Exhibit 95:Exhibit 95: Chinese spend is a growing demanddriver of luxury - estimated spend by nationality

Source: Morgan Stanley Research estimates

The rise of the Asian consumer has had an impact on pricing mix... As shown, the rise ofthe Asian consumer (Greater China) has had a significant impact upon the luxury companies.We estimate that ~50% of sales in Western Europe are made to tourists, with the largestexposure being the Chinese. At the high-net worth level, companies have sought to offermore premium priced goods, some being limited collections (particularly withinwatches/jewellery).

...and also product mix opportunities. We continue to believe aspirational consumers orfirst time luxury buyers in Asia will underpin our luxury growth forecasts. More 'entry level'accessories, e.g. small leather goods, gift items etc., have boosted volumes.


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Beneficiaries of this? Rising consumer wealth and the number of high-net worth individuals is positive for allthe luxury brands. Brands most exposed to the more premium offering with continued pricing power would beRichemont (watches and jewellery) and also LVMH (fashion, leather goods, premium beverages).

Greatest Risks? We do not see a risk specifically to the luxury brands from widening inequality trends -providing the high-net worth population grows along with the rising pool of aspirational consumers from Asia,these companies are well positioned to benefit. The greater risk we see is the shift in demographic - consumersof luxury goods are becoming younger. This may encourage a change in spending behaviour - eg moretraditional luxury goods will have greater competition for wallet share from other areas within consumerdurables (high end technology for example). This could depress pricing power going forward and erode regionalprice differentials (central to our base case and we factor in negative price mix across the peers 2015-17e).

Exhibit 96:Exhibit 96: Greater China acounts for ~30% salesfor the luxury peers...

Excludes Adidas and Luxottica. Source: Company Data; MorganStanley Research estimates

Exhibit 97:Exhibit 97: …But this rises when accounting forChinese spending in a global context*

*Note: Mainland China accounts for ~12% sales for the luxury peers,but the Chinese consumers account for nearer 35%, we estimate.Source: Company Data; Morgan Stanley Research estimates


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Retail: Expanding value segment with expanding inequalityRetail: Expanding value segment with expanding inequality

Audrey Borius, +44 20 7425-5850Kimberly C Greenberger, +1 212 761-6284Edouard Aubin +44 20 7425-3160


We expect widening inequalities to continue reshaping the global retail landscape as they should enablethe emergence of a more prominent Value segment and lead traditional retailers to review their valuepropositions and overall strategies. In this context, we expect the value operators in Europe and the off-price retailers in the US as well as retailers operating at the highest end of the price scale with a clearvalue proposition, strong brand recognition and competitive sourcing and logistic capabilities to benefitfrom the trend.

Widening inequalities combined with the increasing price transparency provided by the internethave started and should continue to reshape the retail landscape in developed countries in the yearsto come. We see mostly three direct impacts on the retail sector both in Europe and in the US:

1) The increasing segmentation of the product offering with a renewed focus on entry price lines formass retailers. The rise of inequalities in developed countries such as the UK has led to the increase in the priceelasticity of the majority of consumers pushing mass retailers to further invest in their price propositionsnotably through the expansion of their entry point ranges. For example, we have observed the expansion of theentry price 'basic' range of fast fashion retailer H&M while it continued initiatives at the other end of the pricespectrum such as the H&M conscious collections and the H&M collaborations with fashion designers. Similarlyover the last couple of years, Inditex relaunched its Lefties format initially used as an outlet for unsold Zara itemsin Spain and Portugal and turned it into a low-cost fast fashion retailer available in the Iberian peninsula, Russiaand online. Finally, UK bikes retailer Halfords announced further investment in its value proposition inNovember 2015 as 45% of its customers check prices online and this number should continue increasing.

2) The sharp expansion of the value retail segment. The UK is becoming increasingly inegalitarian whicharguably contributed significantly to the rise of the value segment in the retail industry over the past decadewhich caught many traditional retailers by surprise. In the clothing industry, with a 14.3% share, Primark nowhas the largest volume share of the UK market well ahead of ASDA at 10.8%, Marks & Spencer at 10.3%, Tesco6.3% and Next at 6.0%. Similarly in Spain, Primark enjoys the largest volume share at 8.8% ahead of El CorteIngles at 5.7%, Decathlon at 4.7% and Zara at 3.1%. In the general merchandise segment, the number of valueretailers and hard discounters in the UK has almost quadrupled between 2001 and 2014 reflecting theincreasing appeal of the segment to consumers.

In the US, since the Great Recession consumers have shifted from consumption focused spending to valuedriven spending. Retailers deeply discounted covetable brands in the 2008-2009 recession, changingconsumers perception of value. The emergence of the "Recessionista” made bargain shopping a badge of pridesuggesting a combination of fashionable and savvy shopper. The off-price retailers (TJX, ROST, BURL) continueto take share from the mid-tier department stores (KSS, M, JCP) and consistently deliver positive low to midsingle digit same store sales, whereas the mid-tier department stores’ are flat to negative at best. Over time weexpect rising inequality to trigger greater market polarization, benefitting lower priced retailers at the expense ofthe broader 'middle' segment.

In the grocery sector, the discount channel in general has been gaining market share in almost every single


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national market over the past decade. Hard discounters (small store size, limited assortment of mostly privatelabel items, etc. ) such as Aldi and Lidl have extended their presence in almost every single European market:they now have a combined market share in the UK, the Netherlands or Ireland of respectively 10%, 16% and20%. Additionally, a number of national 'soft discounters' have also thrived across Europe over the past 10 to 20years. In Belgium, Colruyt now has a market share of 28% (in addition to Aldi and Lidl's 16%), in SpainMercadona's market share stands at 22%, etc. These discounters, in our view have gained market share due to anumber of factor (shift away from 'big box' stores to more convenient formats, increase in cost of unqualifiedlabor partially driven by higher taxation of labor, etc.) including increasing inequality. We do not expect theirexpansion to moderate in the short to medium term.

3) Structural pressures in some categories ininegalitarian societies. One of the most strikingillustrations of the impact of the increasing inequalitiesin the UK is the structural decline of the DIY market. TheUK DIY market has been in decline since 2005 whilemerchants targeting the ‘professional’ end of themarket (Travis Perkins, Howdens, etc) have generallyperformed well in recent years. We believe that themain problem that DIY specialists such as B&Q,Homebase and Wickes face is that, when it comes todomestic repairs and maintenance, the UK is movingfrom a ‘Do It Yourself’ culture to one of ‘Do It For Me’.The UK average house cost £286,000 while nationalincome average £26,500 reflecting the fact that owninga property is becoming increasingly challenging if notimpossible for the majority. Moreover, many houseowners either do not have the skills or the time for home improvement and therefore use service providers,explaining the relatively better performance of home improvement specialist targeting professional vs.consumer focused operators such as B&Q. See our report, Kingfisher: Why is B&Q struggling?Kingfisher: Why is B&Q struggling? February 14,2013.

Most favourably/unfavourably positioned? We expect the value segment to continue expanding asinequalities increase in developed countries creating further deflationary pressure on most categories andexpect the mid- range retailers and the retailers with the weakest perceived value proposition to suffer thesharpest market share losses and margin contraction as a consequence. In contrast, we expect retailersoperating at the highest end of the price scale with a clear value proposition, strong brand recognition andcompetitive sourcing and logistic capabilities, such as Zara, to benefit from the widening inequalities over thenext decades. In the US, we think the off-price retailers (TJX, ROST, BURL) are best positioned. According toEuromonitor, off-price currently represents ~11% of the US apparel market but we think it could potentiallyreach ~15% over the next 10 years.

Exhibit 98:Exhibit 98: Value retailer Sports Direct has aprominent position in the UK sports retailingmarket

Source: Mintel

Exhibit 99:Exhibit 99: The number of value generalmerchandise retailers and hard discounters in theUK has almost quadrupled since 2011

Source: Competition & Markets Authority

Exhibit 100:Exhibit 100: US Off-Price same store sales arenow positively correlated with Softlines’

Sou rce: Compan y data , Morgan Stan ley Research


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https://ny.matrix.ms.com/eqr/article/webapp/2d6a5520-a750-446f-80a6-0a9bc1a2be28?ch=rpint

Technology: Great equalizer until now, but polarization a possibilityTechnology: Great equalizer until now, but polarization a possibility

Katy L. Huberty, +1 212 761-6249Jerry Y. Liu +1 212 761-3735


Mobile devices have provided users with access to communication, the mobile internet and evenencouraged financial inclusion in some countries. We estimate that 2.5B people in the world ownsmartphones, compared to about 1.5 B for PCs. Even so, the companies that offer cheaper devices, ad-based content and bulk volume eCommerce should do better in the long term.

Mobile devices have actually improved equality. We have observed that every technology cycle is roughly10x bigger than the previous one, as infrastructure and ecosystems improve over time while Moore's Law drivescost down. We estimate over 2.5B people in the world own smartphones, compared to about 1.5B for PCs. Whilesome users may have a better experience since they can afford better devices (hardware, software) and services(wireless networks), mobile devices in general have given more people than ever an opportunity to connect tothe Internet, which many countries are starting to recognize as a basic utility, like electricity. And the mobileInternet has given many equality, at least in terms of access to information and ability to communicate, and ithas also increased efficiency and improved the quality of users' lives in many different ways.

The fast pace of technology development allows emerging markets to leapfrog legacy devices andservices, and close the gap vs. developed markets. Emerging markets are arguably surpassing developedmarkets in many ways. The smartphone installed base today is already larger than the PC base and still growing

Exhibit 101:Exhibit 101: Each Computing Cycle is 10x Bigger



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at a faster rate, as many emerging market users are buying smartphones as their first computing device, andskipping desktops and notebooks. And these new users are often quicker to adopt new services and businessmodels.

China is a great example of emerging markets embracing new technologies. It is already the world'slargest smartphone market with 424M shipments in 2015, or nearly 30% of global shipments. Alibaba willgenerate US$452B of gross merchandise volume (GMV) in 2015, mostly in China, more than double Amazon atUS$204B, a large portion of which is in the US or other developed markets. Apple CEO Tim Cook believes Chinawill surpass the US as the company's largest market. He cited a McKinsey study that said China's middle classhad 50M people in 2010 but will grow 10x by 2020.

What happens if inequality of income and wealth persists and widens further over the next 20 years?While technology should continue to improve the lives of all users, a bifurcation of the user base by income andwealth could significantly change business models. Technology companies tend to charge a premium for betterexperience. If the portion of the population that is willing to pay for this premium does not grow, companies willeither have to change their business models or likely face a smaller addressable market than they thought.

Are there any winners from this? Technology is a great equalizer and over time it should and has improve thelives of all users. But if there is a bifurcation, those that offer cheaper devices, ad-based content, and bulk orvolume eCommerce should do better. But this will be a long term trend, so more importantly, it is those that canadapt that will win.

Premium vs. cheap devices: Android smartphone average selling prices have beenincreasing Y/Y in China in recent quarters as users are willing to pay more for a betterexperience. Wealth bifurcation could mean users are more attracted to cheaper prices thanbetter devices. It could also mean a smaller portion of the population will own multipledevices. A high income user is more likely to see the appeal of owning PCs, tablets,smartphones and wearables each for different use cases, while the rest of the market "makedo" with just a smartphone, which is "good enough" for most use cases even if it is notalways optimal.

Subscriptions vs. advertisement-based services: Internet content providers generallymonetize through subscriptions and/or advertisements. Subscriptions tend to appeal to userswho value their time and experience. However, if there are too many subscription servicesand users have "subscription fatigue" and companies realize the addressable market is morelimited than they thought, we may see a shift to more hybrid or advertisement-basedmodels.

Speed vs. free delivery: Established eCommerce companies, like Alibaba and Amazon, andmany startups are building out the technology and/or infrastructure to provide fast delivery.For example, Amazon Fresh offers perishable food deliveries, and several startups includingPostmates and Doordash offer to pick up and deliver cooked food from restaurants. However,our past surveys have shown that users are cost conscious about shipping and handlingexpenses, and startups have picked up on that, for example Jet and Boxed. If incomeinequality widens, fewer people may be willing to pay a premium for speed but rather choosea Costco-like buy-in-bulk model, or just go to a wholesale store in person.


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Transport: Mobility and segmentation provide flexibility to adaptTransport: Mobility and segmentation provide flexibility to adapt

Penelope Butcher, +44 20 7425-6698Rajeev Lalwani, +1 212 761-8518Nathan Hong, +1 212 761-3212David Streger, +1 212 761-5156


As airline assets are moveable and relatively adaptable (i.e. they can be refurbished), there is opportunityfor the airline business models, primarily LCCs, to target both the low income and high income segmentswith different product offerings. The LCCs with the lowest relative cost base should be able to target theprice sensitive end of the market, while hub carriers with targeted investment in premium fleet offers canbenefit from growth in the premium customer segments.

European AirlinesEuropean Airlines

There have been numerous changes in the European airline industry structure over the past twodecades, the main element of which has been the major expansion of the low cost carrier (LCC)industry. In the past decade alone, the market share of industry capacity within intra-EU held by the LCCs hasincreased from 18% to 40%. However, exclusive of the financial crisis in 2008-2009 we have also seenreasonably solid growth in the premium travel segment (first and business class) particularly out of major hubairport locations.

In a similar fashion to the Leisure segment, we observe many airlines are segmenting into high endand low end offers to their customer bases. In the last decade, we have seen the two major LCCs, RYA andEZJ, commence offering a business traveller product, where seat selections and schedule changes are includedin the base fares. EZJ also recently announced it would begin offering a frequent traveller reward scheme,targeted at this end of the customer base. At the other end of the spectrum, the legacy airlines have investedequally in their high end product offerings (Lufthansa for example has spent ~€300m in premium classupgrades in the past 3-4 years) as well as investing in the expansions of their low end economy brands(germanwings and Eurowings at Lufthansa, Transavia at Air France KLM and vueling within the IAG group).

Exhibit 102:Exhibit 102: LCC Airline Share of EuropeanCapacity 2005-2015

Source: OAG

Exhibit 103:Exhibit 103: Growth in Corporate Travel Budgets2013-2016 remains net positive

Source: Morgan Stanley Alphawise Survey 2016


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What happens if inequality of income and wealth persists and widens further over the next 20 years?We believe it will only exacerbate the above trends for European airlines.

Are there any potential beneficiaries from this? In the European airline sector, we believe RYA and EZJwould have the greatest flexibility to capitalise on divergent wealth trends on the intra-EU market. The LCCscould continue to take share in the discount/economy end of the market by utilising their lower cost bases tooffer more attractive pricing to the lower-income brackets. On the premium segment, the LCCs' more flexible

Exhibit 104:Exhibit 104: Lufthansa premium offering - investments have yielded €300m.p.a in last 3 years

Sou rce: Compan y data

Airline assets are mobile and relatively adaptable (can be refurbished) - so the airlinescan theoretically respond to changes in the demand profiles both in developed andemerging markets. The weighting of exposures for the European airlines remain largelyweighted to developed markets - either western EU or North America. Growing wealthdiscrepancies in these markets would only see more of the split investments in high end andmass market product offerings, in our view. While emerging market passenger growth istypically faster growing, for now, these are quite price sensitive markets and therefore favourairlines usually with lower cost bases . This might mean that legacy airline groups in Europewith relatively high labour and infrastructure costs may be affected more by growing wealthinequality than more nimble players.

Premium class investment and differentiation will only be more important, especially asMiddle Eastern and Asian carriers continue to invest heavily in premium offerings to attracthigh wealth and corporate business.

Competitive challenges, regulation and oil/FX may impact outcomes for the Europeanairlines to the inequality themes. As European airlines are heavily regulated and are alsomaterially exposed to USD and oil price swings, the ability to adapt to changes in consumerwealth may be impacted. For example, European airlines are subject to differential carbonemissions regulations than global peers. In addition, many major airport hub in Europe areprivately owned and therefore priced for profits to their owners; this is not the case for manyother global regions. Finally, major changes in the value of the EUR, may decrease thecompetitiveness of the European airlines on the global stage owing to significant items ofopex being denominated in USD.


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offering could also grow further with corporatesincreasing their use of LCCs in the travel budgeting(exhibit 105). Conversely, legacy airlines such as AF-KLM and Lufthansa have a less clear path to capitalisingon changing wealth patterns, in our view. While theyhave a spectrum of brands to potentially tap both thehigh and low income markets, their relatively complexcost structures and less flexible balance sheets make itless clear how they may be able to position themselvesfor changing equality dynamics.

US AirlinesUS Airlines

As the income inequality gap widens and drives further divergence within consumers, those carriers that caterto the more extreme ends of the demand curve are positioned best. We highlight LCCs and ULCCs in particularthat are able to serve consumers with lower price points given slimmer cost structures and legacy carriers withpremium offerings for consumers with higher price points.

Growing LCC presence demonstrates the impact ofan evolving income inequality gap. Over the last 10years, low cost carriers have grown US domestic marketshare from ~21% in 2005 to ~31% in 2015. Thecontinued market penetration of LCCs and ULCCs ispartially a function of robust demand at the lower endof the demand curve. LCCs and ULCCs have beensuccessful at serving these price-sensitive consumersbecause of their cost structures that are structurallyslimmer than mainline peers with more mature laborrelations amongst other factors. We note, however, thatlower fuel somewhat mutes this advantage over thenear-term as mainline carriers are able to competeprofitably at increasingly lower prices.

All the while, premium demand is keeping pace. As income inequality drives the price-sensitive consumersegment higher, it also supports offerings on the other end of the spectrum. In fact, premium traffic growth has

Exhibit 105:Exhibit 105: Use of LCCs as % of total corporatebudgets has been steadily increasing

Sou rce: Morgan Stan ley Alph aw ise Su rvey 2016

Exhibit 106:Exhibit 106: LCC US Domestic Market Share hasExpanded Meaningfully Over the Last 10 Years

Sou rce: O AG , Morgan Stan ley Research

Exhibit 107:Exhibit 107: Premium Trends Keeping Pace withTotal Traffic Exemplifying Demand for Offerings

Source: IATA Premium Traffic, Morgan Stanley Research

Exhibit 108:Exhibit 108: 68% Expect Corporate Bookings toGrow in 2016

Source: Alphawise, Morgan Stanley Research. Question: By whatpercentage do you expect your firm’s airline bookings (passengervolume) to change in 2016 (vs. 2015)?


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largely kept pace with total traffic growth on a global basis per IATA . While volumes have remained robust,legacy carriers have highlighted soft close-in yields to-date which serve as a good proxy for premium pricing.The soft yields are likely driven by elevated supply growth observed in the market this year as well as lower fueland the resulting behavioral dynamics. That being said, our recent corporate travel survey suggests that forwardvolume expectations are strong though airfares are more stable. To the extent that the income inequality gapcontinues to widen, we expect premium traffic growth to outperform total traffic growth as consumersincreasingly target more upscale offerings and corporate volumes stay strong.

What happens if inequality of income and wealth persists and widens further over the next 20 years?The aforementioned divergence only becomes more extreme.

Who are most favourably positioned? Legacies andthe ULCCs. We would expect both carriers that serveboth the higher and lower end of the demand curve tobe well-positioned for growth in income inequalitywhile higher value leisure carriers may lose out. First,ULCCs (ALGT and SAVE) offering the lowest fares in themarketplace are likely to be chosen even more ascustomers become more price sensitive. And on alonger-term time horizon, the ULCC should seerelatively less competition from mainline carriers as fuelrises and lower price levels become less profitable.Second, we believe legacy carriers (AAL, DAL, and UAL)offering premium products will stand to benefit asclose-in yields (which have been soft of late) begin tofirm with the added demand tailwind from higherincome customers.

The mobility of aircraft as fixed assets grants flexibility to airlines to appropriatelyaddress changes in demand. As income disparity widens and consumers becomeincreasingly differentiated on price sensitivity, airlines will have to respond by adjusting faresor adjusting exposures. Fortunately, aircraft are easily transportable assets and carriers thatare experiencing unfavorable trends resulting from the inequality gap can transfer theseassets to geographies that are more favorable.

Unbundling efforts and fare class segmentation will become even more important. USairlines have taken active steps towards providing the best package for all consumersregardless of preference by unbundling offerings and segmenting fare classes. As anexample, Spirit Airlines offers bare fares with no other ancillary products included so as tocater to passengers that are extremely price conscious while avoiding leaving money on thetable for those interested in ancillary offerings. These efforts are pervasive across ourcoverage as ancillaries become increasingly unbundled to provide customers with choice. Inaddition to unbundling, airlines have segmented fares into different classes to cater todifferent legs of the demand curve on the same aircraft. As income inequality widens, bothunbundling and fare class segmentation will be crucial for airlines attempting to servedifferent consumers.

Regulatory oversight may be emphasized to a greater extent in an attempt to protectconsumers. As affording travel becomes more difficult for lower income customers, weexpect regulatory bodies will become even more protective of keeping fares affordable. Thismay, to some extent, mute the impact of widening income inequality on the industry thoughshare shift will likely already be underway.

Exhibit 109:Exhibit 109: Stable Yields Suggest WideningInequality Gap is Neutral for Group with VariousWinners and Losers

Sou rce: A4A Cost In dex Report, Morgan Stan ley Research


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Leisure: Bifurcation with a bent towards the high endLeisure: Bifurcation with a bent towards the high end

Jamie Rollo, +44 20 7425-3281Vaughan Lewis, +44 20 7425-3489

Thomas Allen, +1 212 761-3356


How to navigate the inequality gap? High-end operators such as Starwood, Hyatt, and Shangri-Lashould be best positioned if the income gap continues to widen.

The large publicly listed European Travel and Leisure companies operate principally in the massmarket segment, be they hotel operators, restaurant chains, tour operators, cruise lines, gambling operators, ortheme park operators. Given luxury spend in these industries is a relatively small percentage of total spend, andthe listed companies dominate the contemporary segments, it is difficult to see signs of wealth inequality intheir figures. However, the US lodging industry has both high and low-end operators, and there aresome signs of what growing wealth might have caused in these European industries.

Tour operators in Europe have been reducing their exposure to economy and self-catering holidays, and expanding more into 4 star and all-inclusive hotels.As a result,volumes have been flat for many years, but average ticket prices have increased sharply. Forexample, TUI’s average selling prices have increased by nearly 50% since 2008, and ThomasCook’s by nearly 25%. Operators’ remixing of their revenue base is partly a reaction to defendthemselves against the impact of low cost airlines and the internet which allow customers topackage their own holidays. But it is also partly due to the squeezed middle classes, and adesire to increase exposure to upper socio-demographic groups. The downside is that thishas meant significant restructuring, which has come at some cost to the companies throughongoing cash exceptional costs as they change their business mix and reduce legacy staffand technology costs.

Foodservice operators impacted by more homeworking. The economic downturn andresulting unemployment has contributed to more people switching to being self-employed,working for smaller companies, and setting up flexible working from home arrangements.Given foodservice operators need large captive audience to cover their fixed overhead, thishas been the ‘wrong’ sort of employment. Remote working is growing, and aided byimproved technology, more flexible employment laws, and a shift in employers’ mentality.From the employers’ perspective it is cheaper to outsource jobs to workers who offer thesame talent and productivity as local workers but at a much lower cost, they end up savingbig sums on office space, facilities, and overheads, and it allows employers to retain talent byoffering on-site employees the flexibility to work from home once in a while. From theemployees’ perspective, they look at remote working life-styles as a great way to achievework-life balance. Data is scant, but WorldatWork estimated that 16m employees worked athome at least one day a month in 2010, a number that increased 62% from 2005, and GlobalWorkplace Analytics extrapolate this to get to 25m who currently telecommute occasionally.

High-end hotels have slowly taken over the US market. Over the last 25 years,upscale/luxury hotel rooms have increased from 30% of US branded hotel rooms to 36%,


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What happens if inequality of income and wealth persists and widens further over the next 20years?We would make several general comments in relation to the Travel and Leisure sector.

while the midscale segment has fallen from 23% to 15%, and the economy segmentremained relatively constant at 26-27% until 2005. We viewed this trend to be similar to otherconsumer-facing sectors, and the airline industry, with polarisation into luxury and economyserving a changing population. Over the more recent past, the midscale and economysegments have both become less attractive to developers looking to appeal to a slightlyricher audience with slightly nicer product (at relatively similar development costs). As aresult, both the midscale and economy segments have seen their share of total brandedhotel rooms drop from 20% to 15% and 27% to 24% from 2000-2014, respectively. This hasbeen the result of revenue per available room rising by a 5.3% CAGR in the luxury segmentover the past 25 year, but only 2.3% in the midscale segment and economy 1.7%.

Cruise lines have been moving into more upscale product.In 2014, Norwegian Cruise Lineacquired Prestige, and earlier this year Star Cruises acquired Crystal Cruises. Both areexamples of mass market cruise lines moving into the luxury space. Carnival already ownsSeabourne. At the same time, in the contemporary cruise space, existing ships are beingretrofitted with more premium suites and upscale areas, and new ships have a higher suiteand balcony mix.

Activists allege that gambling operators in the UK have been focusing their machines inareas with a lower socio-economic profile.Research from activist website Stopthefobtsfound that the 50 most deprived local authorities in England had an average of 0.90 FixedOdds Betting Terminals (FOBTs) per 1,000 adults, while the 50 least deprived local authoritiesaverage 0.38. The activists argue that the bookmakers target less wealthy populations with aproduct (FOBTs) that they view as addictive. As we explore in this note, the evidence from aseries of independent reports from the Responsible Gambling Trust contained largely benignconclusions, with clear recommendation for more research that it would be “inadvisable torush policies on the basis of these foundational studies”. However, gambling machinesremain a politically controversial issue, and we think reductions in the maximum stakes orprizes (from £100/£500 respectively), a reduction in the number of permitted machines (from4) or an increase in duty rate (from 25%) remain a possibility in the medium-term.

Pub and restaurant companies in the UK have seen divergent fortunes. Value-led chainssuch as JD Wetherspoon and Hungry Horse have seen broadly no change to their prices overthe last 12 months according to M&C Allegra (at £12.55 and £15.42 dinner spend per headrespectively), whereas Harden’s latest London restaurant guide shows average spend perhead rose 2% to over £50. Around one-third of all respondents to Sacla’s 2015 eating outsurvey said that deals and discounts were in their top 3 reasons for eating out more. And asthe squeezed middle work harder, traditional mealtimes are changing and beingskipped, with the result that ‘grab and go’ is one of the fastest eating out segments.


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http://www.stopthefobts.org/wp-content/uploads/2014/04/Landman-Economics-critique-of-ABB-report-final.docx

https://ny.matrix.ms.com/eqr/article/webapp/0e44f776-7c69-11e4-a118-f2cb50997d55?t=1417776790%3A84%3A22123%3Ahz829c3n6&m=1&ch=Email Safety Catch

Exhibit 110:Exhibit 110: In the US, upscale/luxury hotelrooms have increased from 30% of rooms to 36%over the last 25 years, while Midscale has fallenfrom 23% to 15%

Source: STR, Morgan Stanley Research #pb

Exhibit 111:Exhibit 111: European tour operators have seenstrong average selling prices in the UK as theyhave remixed their holidays away from budgetofferings to more premium all inclusive packages


Exhibit 112:Exhibit 112: UK firms are increasingly allowingemployees to work remotely

Source: CBI, Employment trends survey, Morgan Stanley Research

Exhibit 113:Exhibit 113: The proportion of people self-employed in the UK has grown to almost 15%(TTM)....

Source: ONS, Morgan Stanley Research

Exhibit 114:Exhibit 114: ... while at the same time it hasdeclined to 10% in the US

Exhibit 115:Exhibit 115: Hotel operators' room split byluxury, midscale and economy

Source: Note luxury includes upper upscale, and we group midscaleand lower upscale together

High developed market exposures largely through physical assets. Most of the listedcompanies in our universe generate over 80% of income from developed markets, which iswhere inequality has been increasing. While emerging markets are catching the developedworld up, so increasing exposure here is one way to reduce exposure to these trends.However, these companies have significant assets in developed markets, with only cruiseships having mobile assets, and only online gambling operators living mostly in the virtualworld. Hence, the strategy of growing rapidly in emerging markets is less practical than for


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Are there any potential beneficiaries from this? A simple conclusion might be to back companies with ahigh exposure either to luxury segments, or with a low cost model allowing them to deliver a sustainablebusiness model for the squeezed middle. In the hotel sector, Starwood, Hyatt and Shangri-La have a c. 80%+proportion of their rooms in the luxury or upper upscale segments (note pure luxury under 10% for the firsttwo), suggesting they are well positioned for the growing 1%. Conversely, Whitbread (Premier Inn) and theChinese hoteliers have a very high exposure to the economy brands. Other hoteliers have a high exposure to theMidscale segment (in which we include the Lower Upscale hotel segment).

say consumer goods companies. This might mean that asset-backed leisure companies areaffected more by growing wealth inequality than more nimble retailers.

Luxury is a small part of the European listed leisure companies' revenue mix, as theyoperate in the mass market world. So even if they could remix their business towards highend spending, it probably will not move the dial materially. However, it is higher for some ofthe US and Asian listed operators (e.g. Hyatt, Starwood and Shangri-La).

A change in strategy to move either more upmarket or more into economy segmentswould likely involve significant restructuring costs and write-downs given the high levelof invested capital, staffing and technology in these companies currently geared to theirexisting segments. Already, tour operators have seen a decade of ongoing restructuring,where employee redundancy programmes, technology replacement and investment in moremodern aircraft and hotels have squeezed cash flows. Could other segments like Hotels, Pubsand Restaurants be next?


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Endnotes

See 'Inclusive capitalism: creating a sense of the systemic', Bank of England Governor Mark Carney,27 May 2014

See 'Poverty and Inequality', http://undesadspd.org/Poverty/PovertyandInequality.aspx,

UN

See 'The Economics of the Welfare State', Nicholas Barr, 1987.

See 'Measuring Inequality', http://web.worldbank.org/, World Bank

See ‘Global Income Distribution: From the Fall of the Berlin Wall to the Great Recession’, ChristophLakner, Branko Milanovic 27 May 2014 and ‘Inequality On the Rise?’, UN, December 2012

See Christoph Lakner and Branko Milanovic op.cit. paper and also 'The Future of Worldwide IncomeDistribution', Tomas Hellbrandt and Paulo Mauro, Peterson Institute for International Economics, 1April 2015

The authors of the paper warn that there are some caveats to these calculations due to whichglobal inequality could be underestimated. For example, there is imperfect coverage of poorcountries and also very rich individuals who are often not included in the surveys. And when the latterare included at all, they tend to underestimate their incomes, especially of those derived from theownership of capital. Furthermore, there are large financial assets held in tax havens which are notcaptured either by fiscal or household survey data. See also the work by Gabriel Zucman atwww.gabriel-zucman.eu.

See ‘In It Together’, OECD, 2015, and 'Humanity Divided', UNDP, November 2013

See OECD Income inequality data update: Sweden, January 2015.

See 'Scandinavian Unexceptionalism', Nima Sandaji , Institute of Economic Affairs.

'Is the inheritance boom changing the distribution of wealth in the United States?', Bureau ofLabor Statistics, February 2014.

Edward N. Wolff and Maury Gittleman, 'Inheritances and the distribution of wealth or whateverhappened to the great inheritance boom', The Journal of Economic Inequality, December 2014,Volume 12, Issue 4, pp 439-468.

Outside the “old OECD”, only Chile and Taiwan, Brazil, South Africa and Russia have 1% or slightlymore of their population also in the global top 1%.

See 'Household wealth inequality across OECD countries: new OECD evidence', OECD, June 2015

See Ben Bernanke's Blog, Brookings Institution

See 'Fault Lines: How Hidden Fractures Still Threaten the World Economy', Raghuram G. Rajan,2010

See ' Let Them Eat Credit', Raghuram G. Rajan , August 27, 2017; 'Davos: Mark Carney Calls for techsector to show 'responsibility' over tax, the Guardian, January 23, 2015'; 'Three Truths for Finance,Speech by Mark Carney , 21 September 2015

See 'How to restore a healthy financial sector that supports long lasting inclusive growth?' OECDEconomics Dep. policy Notes, No. 27, June 2015

See http://www.nber.org/papers/w19850

See 'The New Global Middle Class: A Cross-Over from West to East', Homi Kharas and GeoffreyGertz, Wolfenhsohn Center for Development at Brookings, 2010

See 'Doing Better for Families', OECD 2012 and UK Family and Childcare Trust, 2008-2015.

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See 'Out-of-Pocket payments in health care systems in the EU', Hope. September 2015

See Housing Market Insights: Rentership Society Revisited , Morgan Stanley July 2015. See alsohttp://www.oecd.org/eco/outlook/focusonhouseprices.htm.

See "Short-time work benefits revisited: some lessons from the Great Recession," Economic Policy,CEPR; Tito Boeri, Herbert Bruecker 2011.

Conference on Economic Opportunity and Inequality, Federal Reserve Bank of Boston, Boston,Massachusetts, October 2014.

See www.whitehouse.gov/strongmiddleclass

See ‘National vices, global virtue: Is the world becoming more equal?’, Branko Milanovic, 22December, 2014

See ' An emerging middle class', Mario Pezzini, www.oecdobserver.org, OECD

See 'Does income inequality raise aggregate saving? Klaus Schmidt-Hebbel, Luis Servén, Journal ofDevelopment Economics, 2000?'

See ‘In It Together’ OECD, 2015

See Sachverständigenrat, Annual report 2015

See 'Trends in Income Inequality and its Impact on Economic Growth', Federico Cingano, OECDworking paper 163.

http://www.oecd.org/social/Focus-Inequality-and-Growth-2014.pdf

See Education and Socioeconomic Status, American Psychological Association

See 'Childcare in Europe Affect Poor Families Disproportionately' Eurostat, June 2014

see http://aer.sagepub.com/content/50/4/714.abstract

Neuroscientists found that higher-income students have a thicker brain cortex in areas associatedwith visual perception and knowledge accumulation, which can enhance academic achievements. Thistype of research is still in its infancy and did not explore why the brain anatomy is different but otherstudies have shown that low-income students are more likely to suffer from worse nutrition, stressfrom early childhood and receive fewer educational stimuli early in life. See 'Study links brainanatomy, academic achievement and family income', MIT, April 17, 2015

See 'How is Life?' OECD, 2015

See 'Social determinants of health, WHOhttp://www.who.int/social_determinants/thecommission/finalreport/key_concepts/en/.

See 'The risk of gum disease', NHS

See 'Are Recent College Graduates Finding Good Jobs?' Jason Abel, Richard Deitz and Yaquin Su,Federal Reserve Bank of New York Current Issues in Economics and Finance, 2014

Oreopoulos, von Watcher and Heisz estimate that a rise in unemployment by around 5 percentagepoints implies an average initial loss of earnings for new college graduates of around 9%, an effectwhich is estimated to fade only after a decade. See 'The Short- and Long-Term Career Effect ofGraduating in a Recession: Hysteresis and Heterogeneity in the Market for College Graduates,American Economic Journal: Applied Economics, 2012

Bureau of Labor Statistics.

See 'The Inequality Challenge', Uri Dadush and Kemal Dervis, – 'Keeping up with the Joneses',Carnegie Endowment, 2013 and 'Europe pessimistic on inequality as American clings to dream', FT, 17August, 2014

See 'Analysing the link between measured and perceived income inequality in European countries',European Commission, 2009

See 'Exit, Voice and Loyalty: Responses to Decline in Firms, Organizations and States', Hirschman

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(1970); 'The Political Economy of Growth: A critical survey of the recent literature,' World BankEconomic Review, Alesina and Perotti (1993)

see 'How is Life? 2015', OECD

See also Global Issues: Could Demographics Reverse Three Multi_Decade Trends?, September 15,2015 '

Uber is a taxi ride-hailing service company. The company concept was reportedly conceived inParis in 2009, when the American founders could not find a taxi after leaving a conference. The term'uberisation' was originally coined in France but is increasingly used also by the media elsewhere, seefor example 'Uberisation' of economies pinching state tax revenues, www.euractiv.com, 28 September2015.

See 'Skill Bias Technical Change', Giovanni Violante, NYU and CEPR

See 'Technology and Inequality', Daron Acemoglu, NBER, 2003.

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COVERAGE UNIVERSE INVESTMENT BANKING CLIENTS (IBC)STOCK RATING CATEGORY COUNT % OF TOTAL COUNT % OF TOTAL

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